Public Policy in Private
Markets
Vertical Market Restrictions
Announcements
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4/10:
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4/12:
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Assigned reading: Case 17 (K&W, 5th ed.)
Debate # 3
Homework 6 (posted)
4/18:
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Review session (6pm-8pm, room # to follow)
Practice exam due (will be posted on 4/17)
Group Work
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Form groups of 3-4 students
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Suppose you work for LG. Your currently sell LG
products (TV’s, cell phones, etc.) through retailers
(Best Buy, Costco, etc.)
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Your boss has asked you to advise him on the pros and
cons of going to a “doing it yourself” retailing format
(i.e. having “LG retail stores” operated by LG, Apple
has done)
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Write on a piece of 2 cons and 2 pros of this change
(turn it in at the end of lecture for credit)
Pros - cons
Pros:
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Cost ineffective to use a retailer
Cut the middleman
More control
More profits
Quality
Better incentives
Avoiding free riding behavior
Cons:
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More sloppy then a retailer
Loss of focus
Starting from scratch √
Pros - cons
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Pros:
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Better trained salesman / brand reputation
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More effective training
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Increased profit margin (eliminating
middleman)
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Differentiation strategy (Apple effect)
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Efficient shipping/inventory
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More effective advertising (economies of
scope)
Pros - cons
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Cons:
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High operation costs (learning curve)
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LG is not as popular as Apple
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People who are in the retail business
might be more effective/knowledgeable
about local market conditions (promotion)
Overview of Antitrust Laws
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Vertical Market Restrictions
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5th area (and last) of Antitrust (we skipped price
discrimination on purpose)
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Previously discussed vertical issues:
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Vertical mergers
Now, different vertical issues:
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Placing restraints in relationships in a vertical
distribution channel
Vertical Market Restrictions
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Potential anticompetitive effects:
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Exclusionary: can exclude competitors if effect is to
limit who can trade and where
Collusion: price fixing or sharing markets concerns
arise
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Example: Large retailer (Walmart) forces Levi’s
(manufacturer) to push other retailers to a particular retail
price (Toys R US case next Th)
Antitrust laws dealing with vertical restraints
(VR):
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Sherman Act, Section 1: General bans on trade
restraints
Clayton Act, Section 3: Bans specific VR of trade
Vertical Market Restrictions
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This area is becoming more important:
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Franchising is widely used (e.g. McDonald’s)
Franchising practices are often considered VR
4 types of VR:
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Tying (aka bundling)
Exclusive Dealing
Exclusive Territories
Resale price maintenance
All important
in franchising
Tying
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In order to get “A” you must buy “A+B”
Product A is the “tying” product and B is the
“tied” product
Example:
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HP printer (tying product) and HP43 cartridge (tied
product)
Kodak film (tying product) and processing (tied
product)
Important: you must have market power in the
sale of the tying product (otherwise you can’t
force the consumer to buy the tied product)
Tying
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Motives:
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Efficient: cheaper to market products together
Goodwill: franchisor can maintain quality of store
(e.g. McDonald’s franchisees need to buy certain
ingredients from franchisor)
More market power: seller extends market power
from one market to another
Typically: Rule of reason
Not relevant which law firms are judged under
(in recent years both laws have been used)
Tying
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Northern Pacific Railway (1958)
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Spelled out rules of analysis that are used today
Owned large territories to build railroad
Over the years it sold or leased the land under the
condition that buyer or lessee ship all its products on
the Northern Pacific RR
Question: Which are the tying and the tied
products/services?
A. Tying: Land ; Tied: RR service
B. Tying: RR service; Tied: Land
Tying
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Northern Pacific Railway (1958)
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Supreme Court determined Burden of Proof:
1.
2.
3.
Seller has sufficient economic power in market for the tying
product to restrain free competition in the tied good
Seller has substantial commerce in the tied good
Reasonableness of the tie in.
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Ruling in this case: NPRR had sufficient economic
power through its land holdings to affect RR
competition (size of commerce was substantial).
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Approach: Rule of reason
Tying: Burden of Proof
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Sufficient Economic Power in tying market:
1.
2.
3.
4.
Large market share
Patents, copyrights or trademarks
High barriers to entry
Uniqueness or special desirability for the tying good
Tying: Burden of Proof
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Reasonableness:
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In some cases, firm can argue that without tie in,
business is unfeasible
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Example: Jerrold Electronics (1960)
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Tied in equipment, layout and service for community
antenna systems (equivalent of cable systems today)
Argued systems were delicate
Court agreed tie in was ok
Tying: Burden of Proof
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Reasonableness:
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Chicken Delight (1971)
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Forcing franchisees to buy chicken, mixes and equipment
Franchisor: to protect quality
Q: what are the tied and tying products?
Court:
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Sufficient economic power in tying product market
Substantial commerce in tied product market
UNREASONABLE: same quality could have been achieved
under less restrictive means
Reasonableness can not always be claimed.
Exclusive Dealing
Manufacturer A
Retailer 1
Sells: A + B
Manufacturer B
Retailer 2
Sells: A+B
Exclusive Dealing
Manufacturer A
Retailer 1
Sells: A
Manufacturer B
Retailer 2
Sells: A+B
Exclusive Dealing
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Seller forces buyer not to distribute products
from seller’s competitors
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Examples: fast food franchises, Apple store
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Business motives:
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Distributors devote sole attention to 1 manufacturer
(avoids free riding by distributor/retailer)
Manufacturer will invest more on distributor
Better coordination and sales effort
Economies of scale in shipping
Exclusive Dealing
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Why are antitrust laws concerned?
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Clayton Act:
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Exclusivity: other manufacturers looking for an outlet
may not find one, as they are scarce
Exclusive dealing is illegal when used “to
substantially lessen competition or create a
monopoly”
Rule of reason approach.
Exclusive Dealing
Manufacturer A
Retailer 1
Sells: A
Manufacturer B
Retailer 2
Sells: A+B