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Who Will Regulate PoolCo-the FBI?

Fortnightly Magazine - March 15 1995

have seen how the airlines use their computer reservation system to collude, in effect, on price. The federal judge who just approved the settlement of a class action law suit alleging airline price-fixing summarized it this way, as quoted in the Wall Street Journal, Dec. 2, 1994:

"The four-year legal battle stems from allegations that airlines fixed prices by signaling proposed fare changes in the computer reservation system. The carriers didn't admit wrongdoing but agreed to settle for $458 million, which includes the value of the coupons plus legal and administrative expenses."

The Dominant Player Problem

PoolCo proponents will seek to rebut the cartel objection by pointing out that the pool will contain many players, so that a collusive price will not hold. There will always be many players eager to win a share of the market, the argument goes, so the cartel will inevitably break down.

The problem of the "many competitors" retort is that historically it doesn't have much credibility. There may in fact be many competitors. But the more competitors there are (em the ideal world of the PoolCo proponents (em the more weak competitors there will be. Many competitors will be small operators, with single plants and relatively small cash balances. These small players come highly leveraged, with no rich parent. Inevitably, we will see a few players with solid cash balances, untapped lines of credit, and perhaps a rich parent as well.

Against this background, the big player will be able to set the floor price for bidders. Let me make my argument easier by also assuming the big players are also low-cost players. These vendors will then gain enough leverage to win a bid every day. But they don't want to bid low, they want to win while bidding high. And they can force the weaker bidders to bid high. The acceptable floor bid can be dictated through a series of price signals (em low prices to force losses on those not behaving; higher prices to reward good behavior.

By bidding even lower than their own low cost, if necessary to win a large share of the market, the strong can force the weak to bid below cost to stay in the game. Bidding below cost when the bank balance is small cannot go on very long. Thus, the dominant bidder may can break, or threaten to break some of the others. But the dominant bidder may not want to put the weak bidders out of business. Instead, the goal may be simply to discipline the weaker players to bid higher.

PoolCo offers an ideal place to carry out price signaling. Price discipline of this sort is familiar behavior for vendors of electrical equipment (em the worst offenders already operate as partners with some of the bidders in the proposed PoolCo world. Thus, price control behavior could emerge even ahead of the learning curve.

The PoolCo proponents submitted their proposal as if "competition" actually works like the textbooks say. It is difficult to believe that Professor William Hogan really believes that. Even the Nobel Prize Committee