Why the Most Profitable Cartel May Not Last

Background

When firms collude to avoid price competition, it seems natural for them to choose the arrangement that produces the largest combined profit. If one firm can produce more cheaply than another, letting it supply the market and share some of the proceeds with its rival would achieve that goal. Yet this paper shows theoretically that a less profitable arrangement can be the only one the firms can sustain.

The key is that agreeing on how to divide profits and having a reason to honor that agreement are different problems.

Consider two firms that instead agree to charge the same price and both continue selling. Some production then remains with the higher-cost firm, reducing their combined profit. Why might such an arrangement survive when concentrating production in the more efficient firm does not?

One possible explanation is that payments between competitors leave evidence of collusion. This study holds the risk of detection fixed and examines another possibility: uniform pricing can limit imbalances in the division of profits that would otherwise make an agreement break down.

What the paper does

The paper models two firms selling the same product and competing repeatedly on price. The lower-priced firm attracts all demand; if their prices are equal, each receives half. The firms cannot directly assign customers, set sales quotas, or take turns serving the market. They may differ in production costs, in how much they value future profits, and in their bargaining power.

The analysis compares two arrangements. Under profit sharing, the lower-cost firm supplies the entire market at the price that maximizes its profit as the sole supplier and compensates its rival for staying out of active price competition. This maximizes their combined profit. Under uniform pricing, both firms charge the same agreed price, each serves half the market, and no payments pass between them. When costs differ, this arrangement sacrifices some combined profit because the higher-cost firm continues producing.

Before implementing an arrangement, the firms negotiate its terms: the payment under profit sharing or the common price under uniform pricing. They then decide whether to honor those terms each time they interact. If either firm breaks the agreement, both return permanently to price competition. The question is whether the future benefits of continuing the agreement outweigh the immediate gain from breaking it.

The model distinguishes bargaining power, which shapes the agreed terms, from patience, which determines how much a firm values maintaining them. Here, patience can also reflect a firm’s prospects of staying in business and receiving future profits.

What it finds

First, the arrangement that earns the firms more in total need not be the one that both prefer.

When production costs differ and bargaining power is equal, the lower-cost firm prefers profit sharing, while the higher-cost firm prefers uniform pricing. The lower-cost firm can earn a profit even under price competition, giving it a stronger fallback position in negotiations. Equal bargaining power therefore does not imply an equal division of total profit. Under profit sharing, the higher-cost firm’s compensation is smaller than the profit it earns by retaining half the market under uniform pricing.

Second, differences in how much firms value the future can make uniform pricing the only sustainable arrangement.

When production costs differ and bargaining power is equal, profit sharing is easier to sustain if both firms are equally patient. The ranking can change when the lower-cost firm is sufficiently more patient than its rival.

The reason is that the two arrangements put greater pressure on different participants. Under profit sharing, the higher-cost firm may prefer to undercut its rival and capture the market rather than keep receiving its payment. Under uniform pricing, it receives a larger ongoing profit, making the agreement easier for it to maintain. The lower-cost firm faces the harder task: it gives up some of what it could earn as the sole supplier and has a stronger incentive to break the common-price agreement.

If the lower-cost firm values future profits enough, it can resist that temptation. Meanwhile, the higher-cost firm may be patient enough to maintain uniform pricing but insufficiently patient to accept the smaller payment under profit sharing. In that case, the arrangement with lower combined profit survives, while the more profitable one cannot.

Third, uneven bargaining power can give uniform pricing a sustainability advantage even when the firms are equally patient.

Under profit sharing, a stronger bargaining position translates directly into a larger share of the gains from collusion. When bargaining power becomes sufficiently uneven, one participant receives too little to keep honoring the agreement. The flexibility to divide profits freely can therefore undermine the agreement itself.

Uniform pricing limits this effect. Bargaining power can change the agreed price, but both firms continue to receive half the market. This does not equalize profits when costs differ, but a strong bargainer cannot negotiate away the rival’s market share. The resulting limit on distributive imbalances can help sustain collusion. With identical production costs and equal patience, any difference in bargaining power makes uniform pricing easier to sustain than profit sharing in the baseline model.

Why it matters

Understanding collusion requires asking both how much an arrangement earns and whether each participant has a reason to keep following it. Looking only at combined profits can miss why firms maintain a less profitable way to coordinate.

The results also provide a reason why uniform pricing may persist even when firms could make payments to one another and those payments are no more likely to expose the agreement. Its relatively rigid division of demand can protect the incentive of a participant who would otherwise receive too little. This mechanism is especially relevant where firms cannot reliably allocate customers or sales among themselves.

For competition policy, the findings suggest considering production costs, bargaining positions, and firms’ prospects of earning future profits together when assessing which forms of collusion could persist. There is also a cost to leaving production in the higher-cost firm: for a given price and quantity, doing so raises production costs. Lower combined profits for the colluding firms do not necessarily mean smaller losses for society.

This theoretical study compares two arrangements with terms negotiated in advance and maintained over time, in markets where firms cannot allocate customers directly. It identifies a tension between the freedom to divide profits and the ability to sustain an agreement. Even a rule that sacrifices flexibility can help maintain an agreement by preventing an excessively uneven division of the gains.

This research was supported by JSPS KAKENHI Grant Numbers 19K01639 and 24K04912.

About the paper

• Title: Profit Sharing Versus Uniform Pricing in Asymmetric Collusion
• Author: Keisuke Hattori
• Year: 2026
• Publication status: Published in Journal of Industry, Competition and Trade, 26, Article 25 (open access)
• Full paper: https://doi.org/10.1007/s10842-026-00485-w