What Is Horizontal Agreement?
A horizontal agreement is a formal or informal understanding among competing businesses operating at the same level within an industry to coordinate their actions, rather than compete independently. This type of arrangement falls under the broader financial category of antitrust law, which aims to promote fair market competition and prevent harmful business practices. Horizontal agreements typically involve direct competitors and can significantly stifle open markets by reducing consumer choice and leading to higher prices.
History and Origin
The concept of regulating agreements between competitors has deep roots in economic theory and legal history, driven by concerns over market manipulation and the consolidation of market power. In the United States, the formalized opposition to such agreements began with the passage of the Sherman Act in 1890. This landmark legislation was the first federal act to outlaw monopolistic business practices and combinations that acted in restraint of trade.8 The Sherman Act empowered the federal government to take action against trusts and other forms of business combinations that reduced competition.7 It specifically prohibited "every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations."6 Over time, this foundational law was complemented by other key statutes, such as the Clayton Act of 1914 and the Federal Trade Commission Act, which further strengthened federal oversight and enforcement capabilities against anti-competitive behaviors, including horizontal agreements.5 The enforcement of these laws is primarily handled by the Department of Justice and the Federal Trade Commission.
Key Takeaways
- A horizontal agreement is an arrangement between direct competitors at the same level of a supply chain.
- These agreements are generally considered illegal under antitrust laws due to their potential to harm competition and consumers.
- Common types include price fixing, market allocation, and bid rigging.
- Enforcement of laws against horizontal agreements is a core function of antitrust agencies worldwide, aiming to protect consumer welfare.
Formula and Calculation
Horizontal agreements do not involve a specific formula or calculation. Instead, they are characterized by the intent and effect of collaborative actions among competitors. The core issue is whether the agreement reduces competition that would otherwise exist. Antitrust authorities evaluate such agreements based on their impact on pricing, output, innovation, and consumer choice within a defined market.
Interpreting the Horizontal Agreement
The interpretation of a horizontal agreement primarily focuses on its anticompetitive effects. When assessing a horizontal agreement, antitrust agencies and courts typically look at whether the agreement is designed to eliminate or reduce collusion between competitors. Certain types of horizontal agreements, such as explicit price-fixing or market allocation, are considered "per se" illegal. This means that their existence alone is sufficient to prove an antitrust violation, without requiring a detailed analysis of their specific impact on the market or any potential procompetitive justifications. Other horizontal agreements may be evaluated under the "rule of reason," which involves a more thorough assessment of their overall effects on competition, weighing any potential procompetitive benefits against their anticompetitive harms.4 The central question remains whether the agreement serves to stifle legitimate market competition.
Hypothetical Example
Consider a hypothetical scenario in the smartphone manufacturing industry. Suppose two leading smartphone companies, "TechGoliath" and "FuturePhone," which are direct competitors, secretly agree to set a minimum price for their premium smartphone models at $1,200. This understanding ensures that neither company will sell their top-tier phones below this price, effectively eliminating price-based competition between them. This constitutes a horizontal agreement, specifically price fixing.
Before this agreement, TechGoliath might have priced its premium model at $1,100 and FuturePhone at $1,150 to attract more customers. With the agreement in place, consumers are forced to pay a higher price, regardless of which company's phone they choose. This reduces consumer choice and innovation, as the incentive to compete on price or differentiate products significantly diminishes. Such an agreement would be a clear violation of antitrust laws and would likely lead to severe penalties if discovered by regulatory authorities.
Practical Applications
Horizontal agreements are most commonly encountered in the realm of antitrust law and competition policy. Regulators like the U.S. Department of Justice and the Federal Trade Commission actively investigate and prosecute companies found engaging in such practices. These agreements manifest in various forms, including:
- Price Fixing: Competitors agreeing on pricing levels, discounts, or credit terms.
- Market Allocation: Dividing up customers, territories, or product lines among competitors.
- Bid Rigging: Colluding on bids for contracts, often by deciding who will win and at what price.3
- Output Restrictions: Agreements to limit production or sales to drive up prices.
Recent statements from the Department of Justice's antitrust division emphasize that robust antitrust enforcement is essential to prevent corporate practices that harm consumers.2
Limitations and Criticisms
While horizontal agreements are largely condemned under antitrust laws for their anticompetitive nature, criticisms and complexities in enforcement do exist. One challenge is proving the existence of a horizontal agreement, as such arrangements are often covert. Businesses may engage in "tacit collusion," where they align their behavior without explicit agreement, making it difficult for regulators to prove a direct violation.
Furthermore, some argue that strict enforcement can stifle legitimate collaborations between companies, such as joint ventures for research and development, which might offer economic efficiency and benefit consumers in the long run. Regulators must carefully distinguish between illicit horizontal agreements and pro-competitive collaborations that may involve some level of cooperation. The "rule of reason" analysis attempts to address this by considering potential benefits alongside anticompetitive harms, but its application can be complex and subject to debate. Critics also point to a perceived decline in the vigor of U.S. antitrust enforcement since the 1970s, suggesting that business influence may have contributed to a pro-defendant shift in policy over time.1
Horizontal Agreement vs. Vertical Agreement
The primary distinction between a horizontal agreement and a vertical agreement lies in the relationship between the parties involved.
A horizontal agreement occurs between competitors operating at the same level of the supply chain. For example, two competing manufacturers agreeing on pricing or two retailers dividing geographic markets would be horizontal agreements. These are generally viewed with extreme suspicion by antitrust authorities because they directly eliminate competition that would otherwise benefit consumers. Such agreements often lead to a monopoly or oligopoly-like outcome in the market.
In contrast, a vertical agreement involves companies at different levels of the supply chain. Examples include an agreement between a manufacturer and a retailer regarding resale prices, or a supplier and a distributor agreeing on exclusive territories. While some vertical agreements can be anti-competitive (e.g., certain types of exclusive dealing), they are typically analyzed under the "rule of reason" and are not considered "per se" illegal in the same way as most horizontal agreements. The confusion often arises because both types of agreements involve coordination between businesses, but their impact on competition differs significantly based on the market relationship of the parties.
FAQs
What are common examples of horizontal agreements?
Common examples include price fixing, where competitors agree to set prices; market allocation, where they divide customers or territories; and bid rigging, where they coordinate bids on contracts. These actions are generally considered illegal under antitrust laws.
Why are horizontal agreements typically illegal?
Horizontal agreements are usually illegal because they directly undermine market competition, which is essential for a healthy economy. By eliminating competition among rivals, these agreements can lead to higher prices for consumers, reduced innovation, and limited choices, ultimately harming consumer welfare.
Who enforces laws against horizontal agreements in the U.S.?
In the United States, the primary enforcers of laws against horizontal agreements are the Department of Justice's Antitrust Division and the Federal Trade Commission (FTC). These agencies investigate potential violations and can bring civil or criminal charges against individuals and corporations.