4820–12
Vertical
relations
Geir B.
Asheim
Introduction
Vertical relations
4820–12
Framework/
terminology
1 manufacturer & 1
retailer
Intrabrand
competition
and
foreclosure
Interbrand
competition
Conclusion
Geir B. Asheim
Department of Economics, University of Oslo
ECON4820
Spring 2010
Last modified: 2010.04.27
Producers and retailers
4820–12
Vertical
relations
Geir B.
Asheim
Introduction
Outline
Framework/
terminology
1 manufacturer & 1
retailer
Intrabrand
competition
and
foreclosure
Interbrand
competition
Conclusion
Products are sold through retailers.
How does this affect market performance?
Situation:
Monopolist sells to one or more retailers
Questions:
Why does the monopolist want to control
the behavior of the retailer(s)?
Does such vertical control increase or decrease welfare?
Questions:
Why might the monopolist want to refuse
to deal with some retailer(s)?
Does such foreclosure increase or decrease welfare?
Do vertical controls & foreclosure decrease welfare?
4820–12
Vertical
relations
Geir B.
Asheim
Introduction
Outline
Framework/
terminology
1 manufacturer & 1
retailer
Intrabrand
competition
and
foreclosure
Interbrand
competition
Chicago school:
Vertical controls & foreclosure does not lead to
increased monopoly power for the vertical structure;
they are only welfare-enhancing
Legal status:
Many forms of vertical contracts are illegal in different
countries. Why?
Conclusion
Outline
4820–12
Vertical
relations
Geir B.
Asheim
Introduction
Outline
Framework/
terminology
1 manufacturer & 1
retailer
Intrabrand
competition
and
foreclosure
Interbrand
competition
Conclusion
Framework and terminology
Forms of contracting between manufacturers and retailers
Targets, instruments and sufficiency
1 manufacturer & 1 retailer
Double marginalization
Downstream moral hazard
Input substitution
Intrabrand competition (1 manufacturer & several retailers)
& foreclosure (refuse to deal with some retailers)
Retail services
Horizontal externality
Inability to commit
Incentives
Interbrand (several manufacturers & 1 retailer)
Notation
4820–12
Vertical
relations
Geir B.
Asheim
Introduction
Framework/
terminology
Forms of
contracting
Terminology
pw : Wholesale (intermediate) price
p: Consumer (retail, final) price
1 manufacturer & 1
retailer
q = D(p): Consumers’ downward-sloping demand function
Intrabrand
competition
and
foreclosure
q = D(p, s): If demand also depends on
promotional service s exerted by the retailer
Interbrand
competition
Conclusion
Forms of contracting
4820–12
Vertical
relations
Geir B.
Asheim
Linear price: T (q) = pw q
Two-part tariff & franchise fee: T (q) = A + pw q
Resale-price maintenance (RPM)
Introduction
Framework/
terminology
Forms of
contracting
Terminology
1 manufacturer & 1
retailer
(a) Price ceiling (p ≤ p)
(b) Price floor (p ≥ p)
Quantity fixing
(a) Quantity forcing (q ≥ q)
(b) Quantity rationing (q ≤ q)
Intrabrand
competition
and
foreclosure
Tie-in
Interbrand
competition
Exclusive territories under intrabrand competition when different retailers otherwise would have carried the same brand
Conclusion
Exclusive dealing under interbrand competition when a
retailer otherwise would have carried different brands
Terminology
4820–12
Vertical
relations
Geir B.
Asheim
Aggregate profit: The sum of the manufacturer’s and the
retailers’ profits
Introduction
Framework/
terminology
Forms of
contracting
Terminology
1 manufacturer & 1
retailer
Intrabrand
competition
and
foreclosure
Interbrand
competition
Targets: Variables that affect aggregate profit, like the
consumer price and the promotional service
Instruments: Variables that can be specified in a contract
between a manufacturer and a retailer
Sufficiency: Instruments are sufficient if they enable the
parties to maximize aggregate profit
Conclusion
Vertical externality
4820–12
Vertical
relations
Geir B.
Asheim
Introduction
Retailer does not take into account that
Framework/
terminology
1 manufacturer & 1
retailer
Double marginalization
Moral hazard
Input
substitution
Intrabrand
competition
and
foreclosure
Interbrand
competition
Conclusion
pw > c
Wholesale price > Manufacturer’s MC
Double marginalization
4820–12
Vertical
relations
Geir B.
Asheim
Sufficient instruments:
Introduction
Framework/
terminology
1 manufacturer & 1
retailer
Double marginalization
Moral hazard
Input
substitution
Intrabrand
competition
and
foreclosure
Franchise fee
Price ceiling
Quantity forcing
Welfare:
Vertical controls enhance welfare
Interbrand
competition
Conclusion
Downstream moral hazard
4820–12
Vertical
relations
Geir B.
Asheim
Introduction
Framework/
terminology
1 manufacturer & 1
retailer
Double marginalization
Moral hazard
Input
substitution
Intrabrand
competition
and
foreclosure
Interbrand
competition
Conclusion
Sufficient instruments:
Franchise fee
Quantity forcing
Welfare:
Vertical controls enhance welfare
Input substitution
4820–12
Vertical
relations
Geir B.
Asheim
Introduction
Framework/
terminology
1 manufacturer & 1
retailer
Double marginalization
Moral hazard
Input
substitution
Intrabrand
competition
and
foreclosure
Sufficient instruments:
Franchise fee
Tie-in combined with price ceiling
Welfare:
Vertical controls enhance welfare
Interbrand
competition
Conclusion
Intrabrand competition and foreclosure
4820–12
Vertical
relations
Geir B.
Asheim
Introduction
Framework/
terminology
1 manufacturer & 1
retailer
Intrabrand
competition
and
foreclosure
Retail
services
Horizontal
externality
Inability to
commit
Incentives
Interbrand
competition
Conclusion
We now assume that the downstream sector is competitive
Vertical foreclosure: A monopolist has control over the
production of a product or service that is an essential input for
firms in a potentially competitive industry. The competition in
this industry can be altered by the monopolist by denying or
limiting access to the input. The monopolist has control over an
essential facility constituting a bottleneck. Examples:
In network industries: Access needed to deliver product/service
Telecom: AT&T (followed by Baby Bells), Telenor
Power: Statnett
Shipping: Habors
Railway: Eurotunnel
Outside network industries: At an disadvantage without access
Computer reservation systems for airlines
Distribution of goods: retailing chains (food stores,
pharmacies, book stores, pubs)
Retail services
4820–12
Vertical
relations
Geir B.
Asheim
Introduction
Framework/
terminology
1 manufacturer & 1
retailer
Intrabrand
competition
and
foreclosure
Retail
services
Horizontal
externality
Inability to
commit
Incentives
First, retail services that are useful for consumers that buy from
the retailer providing the services
Sufficient instruments:
Resale-price maintenance
Exclusive territory combined with a franchise fee
Welfare:
Vertical controls may enhance or reduce welfare
Interbrand
competition
Conclusion
Horizontal externality
4820–12
Vertical
relations
Geir B.
Asheim
Now, retail services that are useful for consumers independently
of from which retailer they end up buying
Introduction
Framework/
terminology
1 manufacturer & 1
retailer
Intrabrand
competition
and
foreclosure
Retail
services
Horizontal
externality
Inability to
commit
Incentives
Interbrand
competition
Conclusion
Sufficient instruments:
Price floor
Exclusive territory combined with
a franchise fee and pw < c
Welfare:
Vertical controls enhance welfare
Inability to commit
4820–12
Vertical
relations
Geir B.
Asheim
Introduction
Framework/
terminology
1 manufacturer & 1
retailer
Intrabrand
competition
and
foreclosure
Retail
services
Horizontal
externality
Inability to
commit
Incentives
Having contracted with one downstream firm, the upstream
firm has incentives to contract further with other
downstream firms, even though these firms in turn will
compete with the first firm and decrease its profit
The first downstream firm realizes this and is less willing to
sign a contract. This reduces the upstream firm’s profit
The upstream firm will be looking for ways to get around
this problem → Vertical foreclosure
Analog: The durable-good monopolist (“Coase conjecture”)
Interbrand
competition
Conclusion
Incentives
4820–12
Vertical
relations
Geir B.
Asheim
Introduction
Framework/
terminology
1 manufacturer & 1
retailer
Intrabrand
competition
and
foreclosure
Retail
services
Horizontal
externality
Inability to
commit
Incentives
Interbrand
competition
Conclusion
Competition between retailers facilitates the provision of
incentives (from the manufacturer to the retailers)
Vertical controls may lead to cartelization of the retailers
Interbrand competition
4820–12
Vertical
relations
Geir B.
Asheim
Introduction
Framework/
terminology
1 manufacturer & 1
retailer
Intrabrand
competition
and
foreclosure
May exclusive dealing lead to enhanced promotional efforts
from the manufacturer, since – with exclusive dealing –
other manufacturers will not share the benefits?
May exclusive dealing lead to increased barriers to entry and
decreased competition between manufacturers?
Interbrand
competition
Conclusion
Conclusion
4820–12
Vertical
relations
Geir B.
Asheim
Introduction
Framework/
terminology
1 manufacturer & 1
retailer
Intrabrand
competition
and
foreclosure
Interbrand
competition
Conclusion
Competition policy should be governed by rule of reason
It is hard to distinguish between welfare enhancing and
welfare reducing vertical controls