Vertical Relations - Tinbergen

1 1 Vertical Relations MoragaTerminology Manufucturervs. retailer Upstreamvs. downstream Intrabrandcompetition: competition between different retailers selling the same brand; Interbrandcompetition: competition between different Vertical structures2 Vertical Relations Manufacturer-retailer vs. seller-buyerVariables beyond control:Prices to publicQualityPromotional effortAdvertising After-sales 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?

2 Double Marginalisation Quality considerations Restricting competition Law and Cases3 What is worse than a monopoly ?A chain of monopoliesThe double (or triple, ) marginalisation problemDouble MarginalisationPQDMCMRpMqMpRqR M RConsumersurplusMCR=Additional welfare loss4 Internet accessISPI nternetPhone service providerCustomerBackboneDemand for Internet services: Q=A PWhere P=PISP+PTTelecom Profits: T= PT(A-PISP-PT)ISP s profits: ISP= PISP(A-PISP-PT)Telecom company takes into account ISP s pricing behaviorExample: Internet access ISP s profit maximization price: PISP=(A-PT)/2 Telecom profits.

3 T= PT(A - PISP -PT) = PT(A - (A-PT)/2 - PT) Telecom profit maximizing price:PT= A/2 Then PISP= A/4 Telecom profit: T= A2/8 and ISP s profit ISP= A2/16 Joint profit: T+ T= 3A2/16 less than monopoly profits VI= A2/45 Double Marginalisation: solutions Vertical merger (integration) Franchise fees (non-linear prices; two-part tariff) sell for low prices per unit ( mc) ask a fixed sum (close to monopoly profits) Internet example: Telecom offers a lump-sum fee toISP and ISP offers free access Resale price maintenanceIntrabrand competition (service, quality considerations) Potential problems without Vertical restraints: retailersservice efforts insufficientfrom the manufacturer point of view reasons.

4 Free rider problem (positive externality) whenthe returns of providing quality cannot be appropriated(pre-sale service) When there is 1 retailer, Vertical externality. When there are more retailersalso horizontal externality6 Interbrand competition (more externalities) Also free-riding at the manufacturer retailers serve several manufacturers, the latter incentives to provide investments to train salespeople are Integration Positive Efficiency goes up Negative Foreclosure of competition (strategic inputs)7 Price fixing (RPMs) Positive Price celing prevents double marginalisation(when there is almost nointerbrand competition)

5 Price floor prevents free rider problem Negative Price floor (bothinterbrand and intrabrand) stimulates collusionExclusive dealing Positive Prevents free-rider problem in providingservice Enlarges incentive to invest in brands Negative Enlarges possibility double marginalisation-problem to arise (especially when there is littleinterbrandcompetition) May reduce inter-brand competition8 Territorial restriction Positive Returns of providing service can beappropriated Negative Reduces inter-brand competitionAmerican Law Section 1 Sherman Act and Section 3 Clayton Act RPM per se illegal under SA, but increased permisiveness: 1919 Colgatecase Territorial restrictions: Rule-of-Reason approach Exclusive dealing if it lessens competition or tend to create monopoly .

6 (Rule of Reason).9EU 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 Fashio