Cement in Central America: Global players in a local industry: Teaching guide

Abstract

The cement industry provides an ideal setting to explore how contact of firms across markets can reduce rivalry and how this contact might create value added for multinational investment. This note guides the instructor on how to use this case in class. The discussion is organized around three pastures. The first reviews the acquisition of cement assets in Central America by multinationals, analyzes the evolution of capacity and prices, and determines the level of cost asymmetry in each country. The second pasture introduces a simple model that shows how capacity and cost asymmetries affect the viability of cooperative pricing. The third pasture analyzes how contact across the Central American markets by the major multinational cement firms may enhance cooperative pricing and explores how this contact might explain the firms' investment in the region.

Introduction

Starting in the 1990s, the major cement firms pick up the pace of their international acquisitions in Eastern Europe, Asia and Latin America. In Central America, Holcim acquires a controlling share in the incumbent of El Salvador and in one of the two producers in Honduras and Panama; Cemex acquires the state-owned firms in Costa Rica, Nicaragua and Panama, and Lafarge acquires the other operator in Honduras. By 2006 Holcim, Cemex and Lafarge hold a stake in every cement producer in Central America.

High R&D intensity and high advertising intensity are important drivers of multinational investment (Caves, 1996), but these drivers are absent in the cement industry. Ghemawat and Thomas (2008) show that big cement firms do not agglomerate randomly, but rather, tend to locate in countries where they meet the same rivals as in other markets. Such collocation adds value because this practice reduces rivalry.

The cement industry has characteristics that make this business a particularly good setting to test the market power motivation behind multinational expansion (Ghemawat & Thomas, 2008). Since cement firms usually enter new markets through acquisition, industry capacity does not increase (Baum & Korn, 1999). In other industries, the aggressive response by the incumbent to capacity expansion confounds the competition softening effect of entry by firms that are familiar through their joint presence in other locations.

Scholars interpret the relation between multimarket contact and a reduction in rivalry in two ways. Jayachandran, Gimeno, and Varadarajan (1999) argue that multimarket contact leads to greater familiarity between firms and to a clearer understanding of the costs of competitive actions, as rivals perceive a “thicker shadow of the future”. Bernheim and Whinston (1990) use a game theoretic model to show that multimarket contact enhances collaboration when the positions of competitors in different markets are asymmetric. Intuitively, firms restrain from price cutting in markets where they are strong, because they fear punishment in markets where they are weak.

This teaching case provides a particularly fertile setting to explore the relations between multimarket contact, reduced rivalry and multinational investment. Students of this case can measure differences between players in cost and determine intuitively how these differences make the contact across markets attractive. Students can then calibrate a simple model of competition to characterize how multimarket contact might enhance the incentive for collaborative pricing.

In our simple framework each firm assumes that its rival plays a grim trigger strategy in which the rival punishes any undercutting by an indefinite move to a non-cooperative equilibrium. Each firm finds that maintaining the status quo is convenient if its loss from undercutting current prices is sufficiently large in relation to the gain from doing so. The acquisition of cement plants in Central America by multinational players results in a business landscape with cost and capacity asymmetries conducive to reduced rivalry. This case has the following teaching objectives:

• Explain how cooperative pricing might exist in an industry with low product differentiation, which might otherwise experience intense rivalry;

• Show that the impact of multimarket contact depends on firms having asymmetric positions in different markets; and

• Explain multinational expansion in an industry which does not have important brands and is not subject to significant advances in technology.