Exclusive contracts Exclusive
contracts
with imperfect rent extraction
p
+ and P. Zanchettin+
G. Calzolari*, V. Denicolò*
,
*University of Bologna, Italy and CEPR
+University of Leicester, UK
CRESS 2016
1
Exclusivity discounts
Exclusivity discounts
• Exclusivity discounts: granted only if buyer does not purchase from rivals
• Competition policy particularly harsh with exclusive contracts, in C
titi
li
ti l l h h ith
l i
t t i
general very controversial issue
– Many
Many competing theories with different, sometimes opposite, policy competing theories with different sometimes opposite policy
implications
– Limited empirical analyses
– Difficult to translate theoretical findings into simple criteria practically applicable by antitrust authorities and the courts
2
A simple natural seller’ss trade off
A simple natural seller
trade off
• The benefit of exclusive dealing is that it increases the demand (“volume”) of a seller’s product
– Products are (imperfect) substitute
Products are (imperfect) substitute
• The cost is that in order to induce the buyer to accept an exclusive dealing arrangement a price reduction may be
exclusive dealing arrangement, a price reduction may be needed to compensate the buyer for the loss in variety
• Core of the analysis is this price‐volume tradeoff
– Simple but hasn’t been investigated in general
• Note, the benefit only materializes if p>c’ (sellers wants to sell more)
3
This paper
This paper
• A “general” theory : The profitability and the effects of exclusive dealing depend to a large extent only on the fact that extracting the buyer’ss rent is imperfect so that price‐cost margins are the buyer
rent is imperfect so that price cost margins are
positive
The exact reason why rent extraction is imperfect is less relevant
• The exact reason why rent extraction is imperfect is less relevant
– Mathewson and Winter AER 1987 (restrict to linear prices) – Bernheim and Whinston JPE 1998 (Sect. V, moral hazard)
– Calzolari and Denicolò AER 2013, AER 2015 (sellers with incomplete information)
E
Examples of a general theory, as we show in this paper
l
f
l th
h i thi
4
Model
• A
A “dominant” seller that produces a product of better quality or “d i
” ll h
d
d
fb
li
at lower cost, than the rival seller [competitive fringe]
– Competitive advantage
Competitive advantage
• The two products are differentiated for the buyer (likes variety)
• We assume sellers can only offer two‐part tariffs
Pi=piqi+Fi
• Timing
–
–
–
–
Sellers simultaneously offer contracts
Sellers
simultaneously offer contracts
Buyer chooses which contract(s) to sign
[Uncertainty realizes]
Buyer purchases and payoffs realize
• Compare two scenarios
– When
When Exclusive contracts Exclusive contracts
prohibited
– When Exclusive contracts ll
d
allowed
5
Extracting the buyer’ss rent is imperfect
Extracting the buyer
rent is imperfect
• Reduced
Reduced form model: using the fixed fee to extract rent is form model: using the fixed fee to extract rent is
costly, i.e. each € seller i obtains with the Fi costs 1+λ (>1) to the buyer (shock irrelevant here)
– Agnostic about why, but several possibilities
• Piecewise‐linear model with uncertainty: similar to risk‐
aversion but the cost of uncertainty emerges only when losses accrue (“Loss
accrue (
Loss aversion
aversion”)) – Similar to Bernheim and Whinston (1998, Sect. V, moral hazard), we gain full characterization
full characterization
• Difference: with “Loss aversion” the cost of rent extraction is endogenous, with reduced form not. However, very similar d
ith d d f
t H
i il
results
6
Results
1. As soon as marginal prices are distorted above marginal costs (even slightly, i.e. as soon as λ>0,) exclusive dealing is profitable for some levels of the dominant firm’ss competitive profitable for some levels of the dominant firm
competitive
advantage
• Hence, the result that exclusive dealing cannot be directly profitable (“Neutrality”, Berhneim
p
(
y,
and Whinston 1988) is on a )
thin line:
– It holds when the buyer’s rent can be extracted without crea ng any distortion, i.e. only when rent extraction is perfect
7
Results
2. Competitive effects of exclusive contracts follow a simple, general 2
C
ii
ff
f
l i
f ll
i l
l
pattern:
‐ Anti‐competitive
Anti competitive when the dominant firm
when the dominant firm'ss competitive advantage is large
competitive advantage is large
Intuition: Dominant can impose exclusivity without reducing the price too much (the cost of exclusivity)
‐ Pro‐competitive
Pro competitive (or neutral) when competitive advantage is small
(or neutral) when competitive advantage is small
Intuition: a sellers’ Prisoners dilemma, unilateral incentive to offer exclusivity, but then competition intensifies because all prices (Exclusive and Non Exclusive prices) are largely reduced (the cost of exclusivity)
and Non‐Exclusive prices) are largely reduced (the cost of exclusivity)
• These
These pro and anti
pro and anti‐competitive
competitive effects appear as soon as effects appear as soon as
marginal prices are distorted upwards, and irrespective of the exact reason why they are
8
General patter: for any l>0
General patter: for any l>0
Dominant’s firm
f
competitive advantage
Independent
products
Perfect
substitutes
Products
substitutability
9
General patter: for any l>0
General patter: for any l>0
Dominant’s firm
f
competitive advantage
Exclusivity in
equilibrium:
anticompetitive
Neutrality
Independent
products
Pro competitive: Non
Pro-competitive:
Non-E
E
prices lowered by the
possibility to offer E, a
Prisoners’ dilemma
Perfect
substitutes
Products
substitutability
10
Policy implications
Policy implications
• What we like of this theory: its Robustness
– Many details of specific cases may be irrelevant for an trust analysis
– The only condition for the applicability of our theory is simply th t th d i
that the dominant firm's price‐cost margin is positive (and t fi ' i
t
i i
iti ( d
large enough to make the effects that we uncover sizeable)
– If this condition is met (p‐c
If this condition is met (p c’>0)
>0), then antitrust authorities and then antitrust authorities and
the courts can focus on the size of the dominant firm’s competitive advantage
p
g
11
Thank you!
“Exclusive contracts with imperfect rent extraction”
G. Calzolari*, V. Denicolò*+ and P. Zanchettin+
*University of Bologna, Italy and CEPR
+University of Leicester, UK
CRESS 2016