Public Policy in Private
Markets
Vertical Market Restrictions
Announcements
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4/12:
Debate # 3
Homework 6 (posted)
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4/18:
Review session (6pm-8pm, Holdsworth 203)
Practice exam
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will be posted on 4/17
due @ review session
Answer key will be posted on 4/18 (after review)
Overview of Antitrust Laws
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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)
Vertical Market Restrictions
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4 types of VR:
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Tying (aka bundling)
Exclusive Dealing
Exclusive Territories
Resale price maintenance
All important
in franchising
Vertical Market Restrictions
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4 types of VR:
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Tying (aka bundling)
Exclusive Dealing
Exclusive Territories
Resale price maintenance
All important
in franchising
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.
Vertical Market Restrictions
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4 types of VR:
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Tying (aka bundling)
Exclusive Dealing
Exclusive Territories
Resale price maintenance
All important
in franchising
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
Vertical Market Restrictions
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4 types of VR:
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Tying (aka bundling)
Exclusive Dealing
Exclusive Territories
Resale price maintenance
All important
in franchising
Exclusive Territories
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Arrangement between upstream firm (e.g.
manufacturer) and downstream firm (e.g.
retailer)
Coke Bottler
Distributor A
Distributor B
Hampshire County
Franklin County
Exclusive Territories
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Either a geographic area or set of customers
Examples: distribution, franchises
McDonald’s
Franchisee 1
Franchisee 2
Hadley
Northampton
Exclusive Territories
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Upstream Motives:
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Incentive to downstream firm to increase investment,
advertising, quality of service that upstream firm
wants
Can guarantee an appropriate return to downstream
firm
Downstream motive:
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Reduces competition (less intrabrand competition)
Exclusive Territories: Competitive Effects
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Negative: It reduces intrabrand competition
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Positive:
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Coke distributor in Hampshire county does not face
competition from other Coke distributors
Particularly important if firm has large market share
More investment, better services, more quality, more
product variety
It may increase interbrand competition as dealer
makes an effort to beat dealers of other brands
Antitrust policy tries to balance both effects
Exclusive Territories
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Courts: rule of reason approach
Major precedent case: Continental v. GTESylvania (1977)
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Low TV sales:
GTE Sylvania: reduction of retailers + use of
exclusive territories
Result: higher sales
Cut-out retailers (Continental) brought a suit
against GTE-Sylvania
Court:
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Sylvania’s practices ok
Rule of reason approach (no specific guidelines)
Exclusive Territories
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Soft drink industry:
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Has used exclusive territories since early 1900’s
1971, FTC challenged practice
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1980: Coke and Pepsi went directly to Congress
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Territories might not be efficient
1978: FTC ordered Coke and Pepsi to stop practice
“Soft Drink Interbrand Competition Act” exempted SD
industry from antitrust suits over exclusive territories as long
as there is significant interbrand competition
FTC dropped the case
Exclusive Territories
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1989: Purity Products v. Tropicana
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Tropicana dropped Purity products as its dealer in
Baltimore-DC area, because it was selling outside its
territory
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RULE of REASON: court found that Tropicana’s
actions were not unreasonable restraint of trade
Bottom line:
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Law gives lots of room to exclusive territories
Vertical Market Restrictions
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4 types of VR:
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Tying (aka bundling)
Exclusive Dealing
Exclusive Territories
Resale price maintenance
All important
in franchising
Resale Price Maintenance
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Manufacturer specifies minimum or maximum
price that downstream unit can charge
Two types:
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Minimum RPM
Maximum RPM
Antitrust concerns:
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Minimum RPM: Vertical price fixing that can result
in horizontal price fixing
Maximum RPM: Downstream firms’ profits may
be squeezed
Resale Price Maintenance: Motives
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Minimum RPM:
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High prices can maintain quality image: “you get
what you pay for”
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Better coordination across retailers
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Ensure adequate margins for retailers, protects
them from cut-throat competition
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Avoids free riding problem among retailers: retailer
across the street can not undercut retailer with high
sales effort (e.g. a showroom).
Resale Price Maintenance: Motives
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Maximum RPM:
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Reduction of double marginalization problem (very
important)
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Not having intermediaries in the supply chain increases
efficiency
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In practical terms, this allows firm to put a cap on price so
that quantity sold is as high as possible.
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This usually is accompanied by a compensation scheme to
the retailer (e.g. sharing profits)
Oil State v. Khan
Oil State
Other Gas Distributors
(distributor)
Exclusive
Distributor
Retailer y
Khan
(retailer)
Maximum price: Wholesale price + $3.25
Consumers
Retailer x
What is (may be) wrong with RPM?
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Historically viewed as (vertical) “price fixing”,
per se illegal under Sherman Act (section 1)
Price fixing = high profits detriment of
consumers/society, but with maximum RPM:
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Market power by retailer may be limited (good for
consumers)
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Too high a price (bad for consumers)=higher
incentives for retailer (better service, investment,
etc.)
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Why would State Oil seek a price that is too low?
But here is the opposite (i.e. too low a price)
Squeezed margins (anticompetitive):
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But market is relatively competitive, retailers can seek
other distributors
Illegality of RPM
District Court: sided with Khan
Court of Appeals: illegal price fixing
BUT, recommends revisiting Albretch 1968 decision
Supreme Court: overturn Albretch and Court of Appeals
ruling
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Maximum RPM: rule of reason
Minimum RPM: per se illegal (until 2007)
The Changing Law on RPM
1911-1930: Per se illegal under Sherman,
Section 1
1.
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Restraint of trade
1930-1975: largely legal (state laws allowing it)
1975-2007 : Consumer Goods Pricing Act:
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3.
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Per se Illegal, for the most part
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State Oil Co. v. Khan et al. (case 14), maximum RPM
becomes rule of reason
2007- present:
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Rule of reason approach