Vertical restraints – an economic perspective Patrick Rey 9 th Competition Day, Fiscalia Nacional Económica Santiago, 27 October 2011

Patrick ReyVertical restraints - an economic perspective 1 1 Outline Economic impact of vertical restraints Economic impact of vertical restraints Vertical coordination Impact on competition in the short-term Impact on competition in the long-term Policy implications: the case of RPM Policy implications: the case of RPM Efficiency benefits Anti-competitive harm Key factors

Patrick ReyVertical restraints - an economic perspective 2 2 Economic impact of vertical restraints Vertical coordination Vertical coordination Prices: double marginalization omultiplication of margins results in excessive prices osolving double marginalization – via RPM, minimal quotas, non-linear (two-part) tariffs – is good for the firms and for consumers Non-price dimensions oupstream: quality, national advertising,... odownstream: retail services, local advertising,... omore ambiguous welfare implications – price vs services tradeoff – less ambiguous if strong inter-brand competition or free-riding

Patrick ReyVertical restraints - an economic perspective 3 3 Economic impact of vertical restraints Impact on competition in the short-term Impact on competition in the short-term Sham dealer cartels (downstream collusion) Facilitating practices (upstream collusion) Competition-dampening (softening interbrand competition through strategic delegation) Commitment problems (restoring exercise of market power) Interlocking relationships (e.g., national brands in supermarkets)

Patrick ReyVertical restraints - an economic perspective 4 4 Economic impact of vertical restraints Impact on competition in the long-term Impact on competition in the long-term Pro-competitive effects of the above effects oenhancing future profit fosters entry, innovation, investment, … oe.g., launching a new product, entering a new market,... Vertical foreclosure oinput foreclosure ocustomer foreclosure – exclusive dealing – fidelity rebates – vertical integration

Patrick ReyVertical restraints - an economic perspective 5 5 Resale Price Maintenance Efficiency benefits Efficiency benefits Eliminating double marginalization oprice caps opurely bilateral: no need for industry-wide arrangement Alleviating free-riding and encouraging retail services oprice floors opurely bilateral if market is sufficiently transparent

Patrick ReyVertical restraints - an economic perspective 6 6 Resale Price Maintenance Anti-competitive harm Anti-competitive harm No competition-dampening effects Facilitating collusion odealer cartel oenhanced transparency in case of upstream collusion Restoring the exercise of upstream market power osolves manufacturer’s commitment problem orequires retail network – wide arrangement

Patrick ReyVertical restraints - an economic perspective 7 7 Resale Price Maintenance Anti-competitive harm (cont’d) Anti-competitive harm (cont’d) Interlocking relationships (Rey-Vergé JIE 2011) oeliminates interbrand as well as intrabrand competition – retailers as “common agents” (alleviates interbrand competition) – RPM eliminates competition among these agents oFrench experience: the 1996 Galland Act – reselling below cost is forbidden – “cost”? invoice price vs backroom margins oEmpirical validation – price of national brands in supermarkets: France vs EU – Bonnet-Dubois Rand 2011: panel data – Biscourp, Boutin and Vergé: correlation margins/concentration

Patrick ReyVertical restraints - an economic perspective 8 8 Key factors Industry structure Industry structure “Franchising" mode versus interlocking relationships omore serious concern in latter case oin case of “franchising”, market power of “franchisor” Tight oligopolies vs competitive industry (risk of collusion) oentry barriers, small number of competitors, frequent interaction omarket transparency with / without RPM osymmetry, …

Patrick ReyVertical restraints - an economic perspective 9 9 Resale Price Maintenance Bilateral contracts versus industry-wide practices Bilateral contracts versus industry-wide practices Bilateral contracts achieve most of efficiency gains odouble marginalization ofree-riding Industry-wide practice gives rise to potential harm ofacilitating practices and cartel devices ointerlocking relationships

Patrick ReyVertical restraints - an economic perspective 10 Resale Price Maintenance Temporary versus permanent programs Temporary versus permanent programs temporary programs suffice for some efficiency benefits olaunching a new product oentering a new market o… more permanent programs can give rise to potential harm ocollusion / cartel devices ointerlocking relationships