Vertical Agreements

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Vertical Agreements

• Vertical agreements (or restraints) clauses to
  control for the externalities arising between
  firms operating at successive stages of an
  industry
• Plan
• 1. Different types of vertical restraints
• 2. Intra-brand competition
• 3. Inter-brand competition
• 4. Exclusionary effects
• 5. Policy implications

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1. Types of vertical restraints

• Different vertical restraints are used (according
  to observability, absence of arbitrage etc.)
• Franchise fee (FF) contracts
• Resale price maintenance (RPM)
• Quantity fixing
• Exclusivity clauses exclusive territories (ET),
  exclusive dealing (ED), selective distribution
• Tying
• Royalties

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2. Intra-brand competition

• The problem of
• double marginalisation
• vertical integration (VI),
• RPM (ceiling), and
• FF efficient
• ET inefficient.

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Intra-brand competition, II

• Interaction among
• retailers may create
• negative externalities

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Intra-brand competition, III

• Free-riding among retailers and under-provision
  of services VI, ET and RPM (floor) efficient
• (N.B. Substitutability of vertical instruments)
• Quality certification RPM and selective
  distribution
• Free-riding among producers exclusivity clauses
• Exclusivity may also remove opportunistic
  behaviour and promote specific investments

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Intra-brand competition, IV

• Possible anti-competitive effects of vertical
  restraints the commitment problem of an input
  monopolist.
• Example of commitment problem franchise
• Solution of the monopolists problem
• Vertical integration
• Exclusive territories
• Resale price maintenance
• Most-Favoured Nation clauses and
  anti-discrimination laws (transparency is bad)

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3. Inter-brand competition

• Illustration of
• inter-brand
• competition

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Strategic use of vertical restraints

• Two upstream firms U1,U2 sell differentiated
  goods. Demand is given by
• Each upstream firm needs retailer (resp. R1,R2)
  to sell the good
• Zero production and retail cost, for simplicity
• It can be showed that vertical restraints
  (delegation) can be used to increase profits

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Integration v. delegation

• Vertical integration. If R1, R2 are owned by U1,
  U2, one can find equilibrium by solving
• From FOCs one obtains

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VR Two-part tariffs

• 1st stage Ui sets Fiwiqi for Ri. Contracts are
  observable. 2nd stage Ri chooses pi.
• Last stage each Ri maxpipiR(pi-wi)qi (pi,pi).
  Whence, pi(wi,wj), qi(wi,wj).
• First stage each Ui earns Fiwiqi . Therefore,
  Ui wants to maxwipiU(pi-wi)qiwiqi.
• At equilibrium wigt0 and

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Strategic effects of VR intuitions
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Exclusive territories

• Rey and Stiglitz (1988) exclusive territories
  allow manufacturers to relax competition.
• Suppose each (differentiated) Ui has two or more
  retailers perceived as homogenous by consumers.
  Intra-brand competition piwi, and solution as
  if Ui are vertically integrated.
• Suppose now each retailer is given an ET. Then in
  each territory, the game is as the one above, and
  prices will be higher.

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Inter-brand competition, III

• Vertical restraints might also facilitate
  collusion
• 1. Resale price maintenance
• 2. Common agency

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4. Exclusionary effects

• Exclusive contracts and tying can be used as a
  way to deter entry
• (These will be analysed below, as they pertain
  more to the abuse of dominance - art. 82 - than
  to agreements - art. 81)

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5. Policy implications

• Strong presumption VR enhance efficiency
• Possible anti-competitive effects only when
  enough market power exists
• Market power, not the type of agreement adopted,
  matters
• (gt change in the EC approach to VR)
• Large enough market power rule of reason,
  balancing efficiency with (possible) adverse
  effects