Download - Vertical Restraints
Vertical Restraints
Vertical Restraints and the Rule of Reason
John M. GaleEconomists Incorporated
Vertical Restraint: Definition
• Any resale requirement placed on a counter-party as part of a sale– Can place requirements on either the upstream or
downstream firm (e.g. exclusivity can go either way)
• Includes price and non-price restraints– Exclusive territories Snap-on tools– Exclusive dealing and Franchising Cell phones– Performance requirements Acura cars– Tying 3M
Rule of Reason
• Economic theory finds that vertical restraints can be anti- or pro-competitive
• Different economic models find that the same restraint can be good or bad for consumers (actually can be good and bad simultaneously)
• Should some restraints have an enforcement presumption?
• Facts matter– Is there market power?
Effects in Two Markets
• Restraint may make upstream market (manufacturers) more or less competitive– Number of upstream and downstream firms– Higher or lower upstream prices
• Competitive effect of restraint (good or bad) is measured by consumer impact, not effects in the upstream market– Restraint will create winners and losers among
wholesale and retail competitors– Competitor complaints are not dispositive
Example: Effects of RPM
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Demand
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Good RPM
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Example: Effects of RPM• When a manufacturer implements “good” RPM:– Consumers have available products with high retail
service features– High-service retailers can win while discount retailers
may lose– Competing manufacturers can win or lose
• When a manufacturer implements “bad” RPM:– Consumers face higher price without additional value– Entrenched retailers can win while discount retailers
lose– Competing manufacturers can win or lose
Models of Anti-competitive RPM
• Facilitating Retailer collusion to limit retail competition
• Facilitating Manufacturer collusion on wholesale price which subsequently raises retail prices
Models of Pro-competitive RPM
• Induces non-price competition among retailers
• Maintains wholesale margins• Improves quality, variety, and availability• Can facilitate manufacturer entry
Competitive Effects are Measured in the Long Run
• Short run — RPM will always restrict retailer price competition and increase price
• Long run – anti-competitive RPM– Protects retailer market power (one or group of retailers)– Protects manufacturer market power
• Long run – pro-competitive RPM– Non-price competition can improve quality, variety, and
availability– Can protect Manufacturer wholesale margin in long run– Can facilitate Manufacturer entry
Leegin: Facts• Leegin is a manufacturer of fine leather goods• Products sold in small specialty stores and high-
end department stores• Leegin had a published policy of not continuing to
sell to retailers that discounted prices– Exceptions for products not reordered
• Leegin discontinued sales to a retailer that if found to be discounting price
• Retailer sued claiming anticompetitive effects of Leegin policy which was an agreement with retailers
Leegin: Economic Issues
• Supreme Court removed per-se illegality of RPM and mandated a rule-of-reason analysis– DOJ and FTC supported decision
• Does a rule-of-reason analysis find that the Leegin RPM policy good or bad for consumers?
Plaintiff Arguments
• Leegin entered into a price fixing conspiracy with retailers– Leegin was itself the largest retailer
• Leegin has market power in– Retail market for Brighton’s women’s accessories– Sale of branded women’s accessories to
independent retailers• Consumers harmed by higher prices due to
lack of retail competition
Leegin Arguments
• Maintaining retail margins necessary for carriage in preferred retailers– High-end retailers have higher average costs
• Maintaining product image requires limiting price discounting
• Long-run output higher with RPM• No Leegin market power in “women’s
accessories” market• No retailer market power
How to Tell if RPM is Good or Bad
• Output test– If RMP increases output then it is good for
Manufacturers and Consumers– If RPM decreases output then it is bad for Consumers
• Market Power test– If Retailers have market power, RPM may be
protecting Retailers and harming Consumers– If Manufacturers have market power, RPM may be
protecting Manufacturers and harming Consumers– If no one has market power, then there cannot be
anticompetitive effects
Output Test• If Manufacturer output is higher with RPM, then
restriction is good for consumers– Increased output associated with prevention of free
riding and resulting increase in consumer demand– Decreased output associated with retailer or
manufacturer collusion• Analysis must separate short-run and long-run
impact on output– There are always short-run output decreases
• Analysis must value non-price benefits to Consumers and Manufacturers
Market Power Test• Anticompetitive effects rely on retailers having market
power in a relevant retail market– If manufacturers have viable alternatives to reach
consumers, they will not submit to retailer demands• Manufacturers imposing RPM must also have some
market power in a relevant consumer product market– If Retailers have access to good substitute products, then
limiting price competition on a product will have no market impact
• Market power in two separate markets is a necessary condition – Showing market power in both markets is still not
sufficient to prove anticompetitive effects
Leegin Tests
• Leegin claimed that sales were higher due to improved retailer services and improved brand perception
• Court found that single brand cannot be a market – therefore no market power
• Court found that “women’s accessories” was not properly defined or proven – therefore no market power
Conclusion: Rule of Reason• Each instance of a vertical restraint must be individually
examined• Consumer impact is not either-or, a single instance of RPM
may have some pro-competitive and anti-competitive effects– With RPM, one consumer can purchase at a high-service retailer
while simultaneously another consumer if foreclosed from a lower price at a discount retailer
• For an Economist, source of RPM is not dispositive• Properly measured Manufacturer profits may be dispositive
– Must examine possibility of manufacturer collusion– Must examine long run profitability