Vertical Relations. J.L. Moraga

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1 Vertical Relations J.L. Moraga Terminology Manufucturer vs. retailer Upstream vs. downstream Intrabrand competition: competition between different retailers selling the same brand; Interbrand competition: competition between different vertical structures 1

2 Vertical relations Manufacturer-retailer vs. seller-buyer Variables beyond control: Prices to public Quality Promotional effort Advertising After-sales service Etc. Except buyers demand, most variables relevant to a transaction under seller s control Various (more complex) contracts between Manufacturers and retailers are observed: price fixing exclusive dealing territorial restrictions These are vertical restraints: Why? Double Marginalisation Quality considerations Restricting competition Law and Cases 2

Except buyers demand, most variables relevant to a transaction under seller s control Various (more complex) contracts between

3 What is worse than a monopoly? A chain of monopolies The double (or triple, or ) marginalisation problem Double Marginalisation MC R = P p R p M π R π M Consumer surplus Additional welfare loss MC q R q M MR D Q 3

4 Internet access Customer Phone service provider ISP Backbone Demand for Internet services: Q=A P Where P=P ISP +P T Telecom Profits: p T = P T (A-P ISP -P T ) ISP s profits: p ISP = P ISP (A-P ISP -P T ) Internet Telecom company takes into account ISP s pricing behavior Example: Internet access ISP s profit maximization price: P ISP =(A-P T )/2 Telecom profits: p T = P T (A - P ISP -P T ) = P T (A - (A-P T )/2 - P T ) Telecom profit maximizing price: P T = A/2 Then P ISP = A/4 Telecom profit: p T = A 2 /8 and ISP s profit p ISP = A 2 /16 Joint profit: p T + p T = 3A 2 /16 less than monopoly profits p VI = A 2 /4 4

maximization price: P ISP =(A-P T )/2 Telecom profits: p T = P T (A - P ISP -P T ) = P T (A - (A-P T )/2 - P T ) Telecom profit maximizing price: P T = A/2

5 Double Marginalisation: solutions Vertical merger (integration) Franchise fees (non-linear prices; two-part tariff) sell for low prices per unit (e.g. mc) ask a fixed sum (close to monopoly profits) Internet example: Telecom offers a lump-sum fee to ISP and ISP offers free access Resale price maintenance Intrabrand competition (service, quality considerations) Potential problems without vertical restraints: retailers service efforts insufficient from the manufacturer point of view reasons: free rider problem (positive externality) when the returns of providing quality cannot be appropriated (pre-sale service) When there is 1 retailer, vertical externality. When there are more retailers also horizontal externality 5

6 Interbrand competition (more externalities) Also free-riding at the manufacturer level. If retailers serve several manufacturers, the latter incentives to provide investments to train salespeople are curtailed. Vertical Integration Positive Efficiency goes up Negative Foreclosure of competition (strategic inputs) 6

If retailers serve several manufacturers, the latter incentives to provide

7 Price fixing (RPMs) Positive Price celing prevents double marginalisation (when there is almost no interbrand competition) Price floor prevents free rider problem Negative Price floor (both interbrand and intrabrand) stimulates collusion Exclusive dealing Positive Prevents free-rider problem in providing service Enlarges incentive to invest in brands Negative Enlarges possibility double marginalisationproblem to arise (especially when there is little interbrand competition) May reduce inter-brand competition 7

Positive Prevents free-rider problem in providing service Enlarges incentive to invest in brands Negative Enlarges possibility

8 Territorial restriction Positive Returns of providing service can be appropriated Negative Reduces inter-brand competition American Law Section 1 Sherman Act and Section 3 Clayton Act RPM per se illegal under SA, but increased permisiveness: 1919 Colgate case Territorial restrictions: Rule-of-Reason approach Exclusive dealing forbidden if it lessens competition or tend to create monopoly. (Rule of Reason). 8

illegal under SA, but increased permisiveness: 1919 Colgate case Territorial restrictions:

9 EU Law Economics effects approach Black List : minimum retail price exclusive territory Market shares in considerations: When market shares are less than 30% everything apart from black list items allowed. Car market is exception Relation Law - Economic Analysis? Cases Price fixing: 1919 Colgate case, 1988 Business Electronics vs Sharp Electronics, 1997 Khan case Exclusive territories: 1963 White Motor; Schwinn 1967; 1977 Sylvania, EU Car market: VW case; General Motors Exclusive Dealing: 1922 Standard Fashion 9

Car market is exception Relation Law - Economic Analysis?

Price relationship agreements in the UK and EU: a retail-mfn enforcement gap?

MFN Clauses and Antitrust Enforcement and Policy U.S. Department of Justice and Federal Trade Commission 10 September 2012 Price relationship agreements in the UK and EU: a retail-mfn enforcement gap?