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Manufacturer A Retailer 1 Sells

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									Public Policy in Private
Markets

  Vertical Market Restrictions
    Announcements

   4/12:
           Debate # 3
           Homework 6 (posted)
   4/18:
           Review session (6pm-8pm, Holdsworth 203)
           Practice exam
             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
    Pros:
       Better trained salesman / brand reputation
       More effective training
       Increased profit margin (eliminating
        middleman)
       Differentiation strategy (Apple effect)
       Efficient shipping/inventory
       More effective advertising (economies of
        scope)
    Pros - cons
    Cons:
      High operation costs (learning curve)
      LG is not as popular as Apple
      People who are in the retail business
       might be more effective/knowledgeable
       about local market conditions (promotion)
Vertical Market Restrictions



    4 types of VR:
        Tying (aka bundling)
        Exclusive Dealing          All important
                                    in franchising
        Exclusive Territories
        Resale price maintenance
Vertical Market Restrictions



    4 types of VR:
        Tying (aka bundling)
        Exclusive Dealing          All important
                                    in franchising
        Exclusive Territories
        Resale price maintenance
        Tying: Burden of Proof
   Reasonableness:
        In some cases, firm can argue that without tie in,
         business is unfeasible

        Example: Jerrold Electronics (1960)
           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
   Reasonableness:

        Chicken Delight (1971)
           Forcing franchisees to buy chicken, mixes and equipment
           Franchisor: to protect quality
           Q: what are the tied and tying products?
           Court:
               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



    4 types of VR:
        Tying (aka bundling)
        Exclusive Dealing          All important
                                    in franchising
        Exclusive Territories
        Resale price maintenance
Exclusive Dealing

   Manufacturer A   Manufacturer B




      Retailer 1      Retailer 2
     Sells: A + B     Sells: A+B
Exclusive Dealing

   Manufacturer A   Manufacturer B




      Retailer 1      Retailer 2
       Sells: A       Sells: A+B
        Exclusive Dealing
   Seller forces buyer not to distribute products
    from seller’s competitors

   Examples: fast food franchises, Apple store

   Business motives:
        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
   Why are antitrust laws concerned?
        Exclusivity: other manufacturers looking for an outlet
         may not find one, as they are scarce


   Clayton Act:
        Exclusive dealing is illegal when used “to
         substantially lessen competition or create a
         monopoly”


   Rule of reason approach.
Exclusive Dealing

  Manufacturer A    Manufacturer B




                       Retailer 2
   Retailer 1
                       Sells: A+B
    Sells: A
Vertical Market Restrictions



    4 types of VR:
        Tying (aka bundling)
        Exclusive Dealing          All important
                                    in franchising
        Exclusive Territories
        Resale price maintenance
    Exclusive Territories
   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
   Either a geographic area or set of customers
   Examples: distribution, franchises

                        McDonald’s




         Franchisee 1                Franchisee 2

            Hadley                   Northampton
        Exclusive Territories
   Upstream Motives:
        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:
        Reduces competition (less intrabrand competition)
    Exclusive Territories: Competitive Effects

    Negative: It reduces intrabrand competition
       Coke distributor in Hampshire county does not face
        competition from other Coke distributors
       Particularly important if firm has large market share


    Positive:
       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
   Courts: rule of reason approach
   Major precedent case: Continental v. GTE-
    Sylvania (1977)
        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:
           Sylvania’s practices ok
           Rule of reason approach (no specific guidelines)
        Exclusive Territories
   Soft drink industry:
        Has used exclusive territories since early 1900’s
        1971, FTC challenged practice
           Territories might not be efficient
           1978: FTC ordered Coke and Pepsi to stop practice

        1980: Coke and Pepsi went directly to Congress
           “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
   1989: Purity Products v. Tropicana
        Tropicana dropped Purity products as its dealer in
         Baltimore-DC area, because it was selling outside its
         territory

        RULE of REASON: court found that Tropicana’s
         actions were not unreasonable restraint of trade
   Bottom line:
        Law gives lots of room to exclusive territories
Vertical Market Restrictions



    4 types of VR:
        Tying (aka bundling)
        Exclusive Dealing          All important
                                    in franchising
        Exclusive Territories
        Resale price maintenance
    Resale Price Maintenance
   Manufacturer specifies minimum or maximum
    price that downstream unit can charge
   Two types:
       Minimum RPM
       Maximum RPM
   Antitrust concerns:
       Minimum RPM: Vertical price fixing that can result
        in horizontal price fixing
       Maximum RPM: Downstream firms’ profits may
        be squeezed
    Resale Price Maintenance: Motives
   Minimum RPM:
       High prices can maintain quality image: “you get
        what you pay for”

       Better coordination across retailers

       Ensure adequate margins for retailers, protects
        them from cut-throat competition

       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
   Maximum RPM:
       Reduction of double marginalization problem (very
        important)

           Not having intermediaries in the supply chain increases
            efficiency

           In practical terms, this allows firm to put a cap on price so
            that quantity sold is as high as possible.

           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 x
                         (retailer)



             Maximum price: Wholesale price + $3.25


                             Consumers
    What is (may be) wrong with RPM?

   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:
       Market power by retailer may be limited (good for
        consumers)
           Why would State Oil seek a price that is too low?
       Too high a price (bad for consumers)=higher
        incentives for retailer (better service, investment,
        etc.)
           But here is the opposite (i.e. too low a price)
       Squeezed margins (anticompetitive):
           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



   Maximum RPM: rule of reason
   Minimum RPM: per se illegal (until 2007)
         The Changing Law on RPM
1.       1911-1930: Per se illegal under Sherman,
         Section 1
          Restraint of trade
2.       1930-1975: largely legal (state laws allowing it)
3.       1975-2007 : Consumer Goods Pricing Act:
          Per se Illegal, for the most part
             State Oil Co. v. Khan et al. (case 14), maximum RPM
              becomes rule of reason
4.       2007- present:
          Rule of reason approach

								
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