Teboho Bosiu, Farisai Chin’anga & Lauralyn Kaziboni
Participation by a greater number of firms and individuals in the South African economy is hindered by a range of barriers identified in recent CCRED studies, including access to finance. 1 This research indicates that firms attempting to enter a highly concentrated market will likely be denied funding by finance institutions partly due to a high probability of failure. It takes considerable time before a new entrant is able to breakeven, let alone earn profits. As a result, commercial banking and even development finance institutions (DFIs) do not adequately cater for new entrants particularly in those sectors where there are already large established incumbents.
The approach of DFIs tends to be similar to that of commercial banks which apply very stringent criteria to assess the risk of investments in new firms. Applications for finance are cumbersome and lengthy, and entrants are often assessed on historical performance rather than projections and poten-tial for growth over time. 2 Furthermore, assessments consider a shorter period of time as an investment hurdle rate than it generally takes for firms to breakeven and earn profits. As a result, firms that could become effective rivals over time are being excluded from the market, whereas funding that is ‘patient’ and more risk-taking in its approach could aid these firms substantially with long-term gains for the economy.
The issues above motivate for the establishment of forms of patient capital funding 3 to be used as seed-funding for new entrants. The CCRED studies show that success stories for entrant firms have emerged from cases where funding was in the form of a package of support, including assistance with routes to market and longer financing terms, often arising from non-traditional sources of funding such as from competition law proceedings. For example, Soweto Gold which is an entrant in beer production, could not access funding from DFIs and commercial banks because it was not considered a viable investment given the firm would be competing with South African Breweries. Soweto Gold was then funded from the agro-processing competitiveness fund which arose from the Pioneer cartel case proceedings. Similarly, Lethabo Milling that entered in maize meal production was also not considered a feasible investment by commercial banks because the likelihood of success was considered low given high concentration in that particular industry. 4 The entrant was eventually funded and supported through the supplier development fund which arose from the Wal-Mart/Massmart acquisition.
CCRED’s proposal, arising from the research involves the creation of a pool of patient capital that uses as seed capital the funds that are collected through cartel settlements and penalties. We have estimated below how large such a fund could be.
Estimating the size of the pool
Since its inception, the Competition Commission of South Africa has unearthed a number of cartels in various sectors of the economy, and subsequently imposed administrative penalties on firms. Several cartels have involved very large fines for firms. For example, the construction cartel was uncovered in 2009 wherein several companies admitted to collusive conduct in the construction of the 2010 Soccer World Cup stadia, amongst other projects, and were subsequently charged collective penalties of over R1.4 billion in 2013. ArcelorMittal South Africa (AMSA) was recently penalised for its involve-ment in collusive conduct in the flat steel; long steel and scrap metal industries; price discrimination in the carbon wire rod industry; and excessive pricing for flat steel products. AMSA was charged a penalty of R1.5 billion in settlement of the matters.
The Government of South Africa and the South African Fo-rum of Civil Engineering Contractors (SAFCEC) reached an agreement with seven of the construction firms (WBHO, Aveng, Murray & Roberts, Group Five, Basil Read, Raubex and Stefanutti Stocks) to develop a R1.5 billion fund span-ning over 12 years from 2016. 5 The fund aims to achieve socio-economic goals via three commitments: (1) financial contribution for development projects; (2) transformation in the construction sector; and, (3) integrity commitment by chief executive officers. 6 The commitments include agreeing to increase the equity share of black South Africans to 40% in the seven companies; assisting in the promotion of black-owned construction companies; and designing ‘a partner model’ where three emerging black-owned companies are able to grow and reach an annual turnover equal to 25% of the mentoring company’s turnover by 2023. 7 The patient capital fund proposed by CCRED would involve a wider coverage to involve firms across different sectors. CCRED has estimated that cartel penalties levied in the peri-od from 2011 to 2016 amount to over R5 billion (Table 1). While this amount may appear limited, we consider that it constitutes a larger pool of funds than various other initiatives that have had notable success in funding SMEs in South Africa. For instance, the Gauteng Enterprise Propeller (GEP), with an average annual budget of approximately R290 million in 2015-16 managed to support 1 207 SMEs and cooperatives. 8 However, there may be concerns regarding the sustainability of such a fund for two main reasons. The first is that cartel penalties are not stable nor predictable from year to year. Secondly, the Commission’s efforts to implement other measures for increasing deterrence as discussed below, as well as a growing damages culture may mean a smaller pool
of funds over time. There may also be concerns regarding the perverse incentive that can arise to increase penalties unduly in order to effectively fund industry development. These are all valid concerns that could be addressed through careful structuring of programmes to involve recipients in those sectors or downstream industries affected by specific cartels which aids with monitoring of commitments made, and even involving offending firms in assisting to administer the programmes as in the funds discussed above.
Cartel fines, criminalisation and damage claims not enough
It is widely accepted that fines for cartels are not adequate to deter collusive conduct, and damages do not sufficiently compensate for the harm caused to the economy as a whole, particularly through deterring entry. The recent World Bank and African Competition Forum study discussed in the previous edition of this Review, shows that when companies fix prices consumers are likely to pay 49% more on average and this increases to 80% where the cartel is more influential in terms of market share. 11 In South Africa, overcharges for cartels were estimated at 7-42% for wheat products, 25% for poultry, 15% in the pharmaceuticals industry and 7.5-9.7% in cement between 2013 and 2014; with the cartels spanning over eight years on average in non-construction cartels. 12 Yet, in spite of the high overcharges, cartel fines in South Africa are capped at 10% of a year’s total turnover of firms. This generally is not considered sufficient to deter cartel conduct.
Firms will continue to be fined very large amounts for their conduct, however there is a greater understanding that these fines are not enough. The competition authorities have considered measures to enhance deterrence alongside penalties. These include the amendment to the Act under section 73A(1) to (4) which became effective in May 2016 stating the criminalisation conditions for a manager or director involved in anti-competitive conduct. 13 This means that criminal cases can now be pursued against representatives of companies involved in cartels, which may result in jail time or a financial penalty. This should deter individuals party to decisions involving establishment of cartels, and/or incentivise management into creating strong mechanisms and awareness to educate employees about the risks of collusive behaviour.
The possibility of damage claims over and above penalties levied by the competition authorities may help to compensate victims for losses suffered. For instance in 2016, Nationwide Air-lines was awarded a damage claim of R104.6 million against South African Airways arising from SAA’s contravention of section 8(d) through the use of an incentive scheme offered to trav-el agents leveraging its dominant position in the domestic air travel markets. 14
Implications
It is likely to take some time before criminalisation proceedings and a culture of damages claims gains momentum in the South African context. On the other hand, there are already clear and functional mechanisms for penalising or settling cases with offenders which in just five years, have brought in more than R5 billion in penalties. The approach proposed here is to consider alternatives in terms of thinking about the purpose served by these funds. If cartels are shown to cause harm in terms of limiting entry and charging high prices to consumers, then the proceeds should be used directly or indirectly to increase and support entry which in turn results in dynamic gains from rivalry including lower prices in the medium- to long-term.
In many ways, this approach seeks to ‘repair’ the damage caused by conduct through considering how entrants and smaller firms can be supported. Cartel fines currently go into the National Revenue Fund, but could be used to promote a much more competitive environment through a patient capital fund similar in its design to funds that have already been established from other cases. This includes the R240 million supplier development fund that was set up following the Wal-Mart/Massmart merger, aimed at assisting SMEs and suppliers for Massmart’s supply chain;15 and the R180 million agro-processing competitiveness fund that was set up following the Pioneer Foods settlement with the Commission as a result of its involvement in the bread cartel. These funds have already benefited black-owned companies like Lethabo Milling and Soweto Gold and lessons from the implementation of these important initiatives could be drawn on to shape the nature of the patient capital pool.
As South Africa battles to transform its economy and repair harm caused by a previously exclusionary economic and political structure, it may be worthwhile to think proactively about how we can use what is available in an environment of scarce resources to change the shape of the economy for the long-term. The proposal above aims to contribute in this regard.
Notes
1. Matumba, C. and Mondliwa, P. (2015). Barriers to Entry for Black Industrialists - The Case of Soweto Gold's Entry into Beer. CCRED Working Paper No. 2015/11.
2. Ncube, P., Nkhonjera, M., Paremoer, T. and Zengeni, T. (2016). Competition, barriers to entry and inclusive growth: Agro-processing. CCRED Working Paper 2016/3.
3. A patient capital fund allows a funder to invest in a business without expecting immediate profits.
4. Roberts, S. (2016). An Agenda for Opening up the South African Economy: Lessons from Studies of Barriers to Entry. CCRED Policy Brief.
5. South African Forum of Civil Engineering Contractors (SAFCEC). ‘Major Participants in the SA Construction Industry Reach Transformative Agreement with Government’ (11 October 2016).
6. See note 5.
7. See note 5.
8. Gauteng Enterprise Propeller. Annual Report 2015-2016.
9. Own compilation from the Competition Tribunal Consent Orders and The Competition Commission of South Africa Annual Reports dating from 2011 to 2016.
10. The calculation is based on penalty decisions made between 01 January 2016 and 19 October 2016.
11. World Bank Group and African Competition Forum. (2016). Boosting Competition in African Markets.
12. See note 8.
13. Manyathi-Jele, N. ‘The criminalisation of cartel conduct’ (01 July 2016). De Rebus.
14. Competition Tribunal. ‘Nationwide Airlines (Pty) Ltd, Comair Ltd vs South African Airways (Pty) Ltd, Case No 80/CR/Sep06’ (17 February 2010). Competition Tribunal Complaints; and Judgment of the High Court of South Africa (Gauteng Local Division) in the matter between Nationwide Airlines (in liquidation) and South African Airways, Case No. 12026/2012 (8 August 2016).
15. Massmart. Massmart Supplier Development Fund.