1. Public Policy in Private Markets Vertical Market Restrictions

2. 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)

3. Overview of Antitrust Laws √ √ √

4. 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)

5. 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)

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

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

8. 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

9. 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.

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

11. Exclusive Dealing Manufacturer A Retailer 1 Sells: A + B Retailer 2 Sells: A+B Manufacturer B

12. Exclusive Dealing Manufacturer A Retailer 1 Sells: A Retailer 2 Sells: A+B Manufacturer B

13. 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

14. 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.

15. Exclusive Dealing Manufacturer A Retailer 1 Sells: A Retailer 2 Sells: A+B Manufacturer B

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

17. Exclusive Territories Arrangement between upstream firm (e.g. manufacturer) and downstream firm (e.g. retailer) Coke Bottler Distributor A Hampshire County Distributor B Franklin County

18. Exclusive Territories Either a geographic area or set of customers Examples: distribution, franchises McDonald’s Franchisee 1 Hadley Franchisee 2 Northampton

19. 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)

20. 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

21. 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)

22. 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

23. 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

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

25. 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

26. 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).

27. 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)

28. Oil State v. Khan Oil State (distributor) Other Gas Distributors Khan (retailer) Exclusive Distributor Retailer x Retailer y Consumers Maximum price: Wholesale price + $3.25

29. 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

30. Illegality of RPM Maximum RPM: rule of reason Minimum RPM: per se illegal (until 2007) 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

31. 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