Public Policy in Private Markets

Vertical Market Restrictions

Announcements

4/10: Assigned reading: Case 17 (K&W, 5th ed.)

4/12: Debate # 3 Homework 6 (posted)

4/18: Review session (6pm-8pm, room # to follow) Practice exam due (will be posted on 4/17)

Group Work Form groups of 3-4 students

Suppose you work for LG. Your currently sell LG products (TV’s, cell phones, etc.) through retailers (Best Buy, Costco, etc.)

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)

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: Cost ineffective to use a retailer Cut the middleman More control More profits Quality Better incentives Avoiding free riding behavior

Cons: More sloppy then a retailer Loss of focus Starting from scratch √

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)

Overview of Antitrust Laws√

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Vertical Market Restrictions

5th area (and last) of Antitrust (we skipped price discrimination on purpose)

Previously discussed vertical issues: Vertical mergers

Now, different vertical issues: Placing restraints in relationships in a vertical

distribution channel

Vertical Market Restrictions

Potential anticompetitive effects: Exclusionary: can exclude competitors if effect is to

limit who can trade and where Collusion: price fixing or sharing markets concerns

arise 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):

Sherman Act, Section 1: General bans on trade restraints

Clayton Act, Section 3: Bans specific VR of trade

Vertical Market Restrictions

This area is becoming more important: Franchising is widely used (e.g. McDonald’s) Franchising practices are often considered VR

4 types of VR: Tying (aka bundling) Exclusive Dealing Exclusive Territories Resale price maintenance

All important in franchising

Tying

In order to get “A” you must buy “A+B” Product A is the “tying” product and B is the

“tied” product Example:

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

Motives: 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

Northern Pacific Railway (1958) 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 serviceB. Tying: RR service; Tied: Land

Tying

Northern Pacific Railway (1958) Supreme Court determined Burden of Proof:

1. Seller has sufficient economic power in market for the tying product to restrain free competition in the tied good

2. Seller has substantial commerce in the tied good3. Reasonableness of the tie in.

Ruling in this case: NPRR had sufficient economic power through its land holdings to affect RR competition (size of commerce was substantial).

Approach: Rule of reason

Tying: Burden of Proof

Sufficient Economic Power in tying market:

1. Large market share2. Patents, copyrights or trademarks3. High barriers to entry4. Uniqueness or special desirability for the tying good

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.

Exclusive Dealing

Manufacturer A

Retailer 1Sells: A + B

Retailer 2Sells: A+B

Manufacturer B

Exclusive Dealing

Manufacturer A

Retailer 1Sells: A

Retailer 2Sells: A+B

Manufacturer 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

Retailer 1Sells: A

Retailer 2Sells: A+B

Manufacturer B