Session 8: Vertical restraints and nonhorizontal

Transcription

1 Session 8: Vertical restraints and nonhorizontal mergers CCP Economics of Competition Policy Course 6 October 2017 Agenda 1 Vertical restraints 2 Vertical (and conglomerate) mergers 3 Retail MFNs David Parker david.parker@frontier-economics.com 2 1

2 1 Vertical restraints 2 Vertical (and conglomerate) mergers 3 Retail MFNs 3 A simple model of a vertical relationship Basic set-up Supplier x Retailer A End Customers Supplier y Retailer B Suppliers set: Wholesale prices (potentially both unit prices and fixed fees) Supplier level promotion Retailers set: Retail prices Retail service levels Complexities Multiple levels Other price models (e.g. rebates, royalties, other restraints) 4 2

3 Vertical restraints Vertical restraints involve a restriction, by agreement, of the decisions of one or both parties. The aim is usually to better align parties incentives. level of service offered by a retailer may affect demand for a supplier s product - supplier would like to ensure retailer provides this level of promotion carried out by a supplier may affect demand for a supplier s product retailer would like to ensure supplier provides this Vertical restraints can change incentives in two ways: directly by contractually restricting at least one of the parties, in terms of purchasing, selling or reselling certain goods and services; indirectly by limiting competition at one or other level, which changes payoffs at that level 5 Key categories of vertical restraint - I (NB See 2010 EC Guidance on VRs) Single branding Buyer (retailer in simplest case) obligated to procure a specific product/brand from a single supplier. Exclusive distribution Each distributor allocated a specific territory, for which it is sole distributor. Exclusive customer allocation Supplier agrees to sells its products to only one distributor for resale to a particular group of customers. Selective distribution Franchising Restriction on number of distributors, often based on qualitative criteria linked to nature of products and the complementary services to be provided to buyers. Arrangement where one party grants to another the use of its trademark and business processes to produce a good or service to certain specifications. 6 3

4 Key categories of vertical restraint - II (NB See 2010 EC Guidance on VRs) Exclusive supply Upfront access payments Category management Tying and bundling Supplier obligated to sell relevant products to a single buyer. Fixed fees suppliers pay distributors to get access to distribution network. AKA slotting allowances. Distributor entrusts supplier to market a category of products including those of its competitors. Tying: Can buy tying product only if buy tied product. Bundling: Can only buy products in fixed proportions. Resale price restrictions Maximum/fixed/minimum RPM: Price ceiling/level/ floor set by supplier Most Favoured Nation clauses 7 Why might firms want to impose vertical restraints? To align incentives for efficiency reasons To restrict or distort competition To address inefficiencies: Double marginalisation Free rider problems Incomplete contracts Supplier x 8 4

5 Vertical relationships are fundamentally different to horizontal relationships General presumption (unlike horizontal agreements/restrictions between competitors) that vertical agreements are only harmful in certain circumstances Key issue: firms in a vertical supply chain are complements, not substitutes 9 which is reflected in how competition law is set up in terms of identifying issues General presumption (unlike horizontal agreements/restrictions between competitors) that vertical agreements are only harmful in certain circumstances Article 101(1)/Chapter 1 CA98 and equivalent Note appreciably 10 5

6 and potential rationales General presumption (unlike horizontal agreements/restrictions between competitors) that vertical agreements are only harmful in certain circumstances Article 101(1)/Chapter 1 CA98 and equivalent Article 101(3)/Chapter 1 CA98 and equivalent And even here there is a getout clause 11 EC 2010 Vertical Agreements Block Exemption Regulation (VABER) Hardcore restrictions Fixed/minimum RPM Absolute territorial protection A number of restrictions on distributors ability to sell freely online Case by case analysis required Everything else.but generally more likely to be exempt if looks more like something that would be exempt Block exemption (or no infringement) Exempt: Most non-price restrictions, so long as buyer and supplier both have less than 30% market share. No infringement for purely qualitative selective distribution, max RPM or agency arrangements 12 6

7 Key efficiency benefits - 1. Reducing double marginalisation Supplier x Retailer A Supplier mark-up Retailer mark-up Suppliers set wholesale prices, inclusive of a margin set to maximise their own profits, not taking account of the effect on retailers sales and profits Retailers add a supra-competitive margin not taking account of the effect on suppliers sales and profits e.g. suppose (for illustration) there is an upstream and a downstream monopoly Consumers face higher prices and lower output than with vertical integration with VI, firms can internalise these effects 13 Key efficiency benefits - 1. Reducing double marginalisation Supplier x Retailer A End Customers Supplier y Retailer B Firms don t necessarily need to vertically integrate to solve double marginalisation problem vertical restraints may be enough RPM: Although NB Maximum RPM is usually sufficient! Quantity forcing: Require retailers to sell minimum quantities of product Fixed (franchise) fees, plus exclusive territories or customer allocation: This makes retailers residual claimant over monopoly profits, which are then extracted via fixed fee. 14 7

8 Key efficiency benefits - 2. Reducing downstream free-riding Retailer ambience and service can be important for generating consumer demand for a supplier s products. But these can be costly for retailers. Retailers will thus only invest in them if they can charge retail prices that reflect these costs. This can be compromised if competing retailers can win customers away, at lower prices, without incurring these costs. This free rider problem is a classic prisoner s dilemma everyone benefits if everyone makes effort, but each retailer has an incentive to freeride and not invest. Online vs. bricks and mortar is a common example 15 Key efficiency benefits - 2. Reducing downstream free-riding Examples of potentially useful vertical restraints to solve free-riding problem: RPM: Limits ability for non-investers in service to win customers through offering lower prices. Exclusive distribution and a fixed (franchise) fee: Make retailer residual claimant from benefits of investment in service. Profits then extracted via fixed fee. Selective distribution: This allows the supplier to restrict distribution to those retailers that are willing to provide the service. 16 8

9 Key efficiency benefits more generally Vertical restraints generally have efficiency benefits when they resolve differences in incentives between different levels of the chain. Other examples include: Achieving a wide distribution network Facilitating entry into a new market Reducing hold-up of relationship-specific investments Incentivising retailers to provide a quality certification role for suppliers Efficient allocation of risk Efficient use of asymmetric information Need to think hard about the specifics of each situation 17 The one monopoly profit theorem Most generally discussed in respect of refusal to supply (a form of vertical restraint) but more general. The theorem runs as follows: Suppose an upstream monopolist refuses to supply one or more downstream firms, such that competition is reduced downstream. Unless there are efficiency benefits, this can only be bad for the monopolist. There is only one monopoly profit and the firm has already extracted it. Perfect competition downstream will always be preferable in that it prevents double marginalisation. Thus, if we do see vertical restraints imposed by a monopolist at one level that change competition at another level, this must be motivated by efficiency benefits. This is also known as the Chicago Critique. (See Posner (1979), The Chicago School of Antitrust Analysis) 18 9

10 The influence of the Chicago Critique This argument was highly influential for a long period in competition policy, especially in the US in the 1960s-1970s, and led to a relatively non-interventionist stance, including in the area of abuse of dominance (monopolisation). However, a plethora of post-chicago models (1980s IO) show that the theorem is based on fairly restrictive assumptions: It may not hold if there is not a pure monopoly upstream And even if there is, refusal to supply can potentially still be used to better extract monopoly rents, protect a monopoly position or extend market power. Today it is more usually considered in vertical restraints models as a participation incentive constraint: Why would the various parties to this agreement have an interest in participating and adhering to it? 19 Potential concerns with vertical restraints Supplier x Supplier y Facilitate upstream collusion Facilitate downstream collusion Foreclose upstream competition Retailer A Retailer B Foreclose downstream competition Soften upstream competition End Customers Soften downstream competition Soften competition at both levels 20 10

11 Inter-brand and intra-brand competition Retailer A sells both product x and product y this is interbrand competition Supplier x Retailer A Supplier y Retailer B Retailer A and Retailer B both sell product y this is intrabrand competition End Customers Vertical restraints can affect both types of competition (often in different ways, e.g. exclusive territories) 21 Exclusivity arrangements in supermarkets (1) Common situation New shopping centre been developed Shopping centre owner does a deal with a supermarket to be the only supermarket at the shopping centre Rival supermarkets cannot enter Question: Is this good or bad for competition? Exclusivity arrangement Supermarket 1 Shopping centre Supermarket

12 There are pros and cons Bad for competition between supermarkets, if relevant geographic market is the shopping centre Shopping centre 2 Supermarket 1 Shopping centre 1 Exclusivity arrangement Supermarket 2 Shopping centre 3 Good for competition between shopping centres, if supermarket acts as an anchor tenant and makes shopping centre profitable and if so may also be good for competition between supermarkets 23 reflected in the approach of the Competition Commission Groceries inquiry (2008) took a balanced view Prohibition on enforcing existing arrangements in highly concentrated local markets (<=3 fascia, 60% share of grocery floorspace for the relevant retailer) Limit on term of new exclusivity arrangements to 5 years (all local markets) Recent cases Tesco vs. High Peak Dunnes vs. Peninsula 24 12

13 OFT Hasbro case (2003) RPM on children s toys RPM considered to be an object infringement, but useful to explore the economic effects (theories of harm) Two key bilateral agreements that Littlewoods and Argos would both set prices at Hasbro s RRP. Littlewoods and Argos leading high street catalogue retailers Strong branded goods (Action Man, Monopoly, Furby) What questions would you ask to see if there was real detriment? 25 OFT Hasbro case (2003) RPM on children s toys Some key facts: Hasbro leading supplier in some markets/segments, but not more generally No evidence of other suppliers engaging in RPM Argos leading retailer, but not a huge share. Main competitor (at that point) was Woolworths. Initiative driven by Hasbro, but in response to retailer dissatisfaction with margins and threats to delist Is there really a theory of harm? 26 13

14 OFT Hasbro case (2003) - RPM on children s toys Yes! (According to the OFT.) Argos seen as price leader across market, so if it agreed to follow RRPs, others would follow. But catalogue prices set on one-off basis, so if Littlewoods cheated, effect would last. Argos thus required that Littlewoods agree RPM too. Impact then felt across market. Effectively a retailer collusion story (Q: following the Chicago critique, what was the benefit to Hasbro?) 27 EC e-commerce sector inquiry Published May Concerns around: Online sales restrictions Pricing restrictions Marketplace bans Selective distribution e.g. bans on pure online retailers Dual pricing (different prices to same retailer for online and offline sales) Geo-blocking and price discrimination by location (more single market concerns) 28 14

15 Some recent UK CMA vertical restraints cases Case name Product Year Issue Pride and Roma Ultra Finishing ITW (Foster Refrigerator) Ping Expedia and Booking.com Mobility aids Bathroom fittings Commercial fridges Golf clubs Hotel online booking 2013/ 2014 Ban on online advertising at below RRP online (Pride) Ban on online pricing on online sales (Roma) 2016 Online RPM (SO) 2015 (closed) Ban on advertising at below RRP online Ban on online sales Retail price MFN. Case closed as clauses dropped. Similar cases in other national jurisdictions 29 1 Vertical restraints 2 Vertical (and conglomerate) mergers 3 Retail MFNs 30 15

16 Non-horizontal mergers come in various forms Vertical Supplier Supplier of product A Conglomerate Supplier of (noncompeting) product B Diagonal Supplier of product A Supplier of product B Retailer Retailer 31 and are different to mergers of substitutes Vertical and conglomerate mergers are mergers between complementary products Merger allows one party to benefit from the effect that cutting prices has on the sales of the other party Starting point is that merger should lead to a reduction in prices Vertical: reduce double marginalisation Conglomerate: Cournot effect (horizontal analogue) But such mergers can lead to foreclosure concerns 32 16

17 Foreclosure effects of vertical mergers: 1. Input foreclosure Pre-merger Retailer 2 has a choice of suppliers. Post-merger, the vertically integrated firm may refuse supply to Retailer 2 (or charge it higher wholesale prices). Supplier A Supplier B Directly unprofitable for Supplier A (loss of upstream margins). Why would it do this? Weaken Retailer 2 s choices and raise its costs (feed through to prices depending on pass-through). Divert downstream sales to Retailer 1 gain downstream margins Retailer 1 Retailer 2 Incentive to foreclose depends on balance of these two factors Influenced by ability of Retailer 2 to source from Supplier B Comparatively rare combination of circumstances where these factors outweigh double marginalisation benefits 33 Foreclosure effects of vertical mergers: 2. Customer foreclosure Pre-merger Retailer 1 has a choice of suppliers. Post-merger, vertically integrated firm may refuse to purchase from Supplier B. Analogous situation. Supplier A Supplier B Directly unprofitable for Retailer 1 (move to less profitable option). May choose to do so if Supplier B is weakened as a result and exits/does not expand, to the benefit of Supplier A Retailer 1 Retailer 2 Requires that Retailer 1 is a critical route to market for Supplier B 34 17

18 Total vs. partial foreclosure Always some incentive to engage in partial foreclosure (why?) Total foreclosure Complete refusal to supply/purchase Maximum foreclosure impact But also maximum detrimental impact on the merging firm Partial foreclosure Raise prices slightly or reduce purchases slightly Limited foreclosure impact But also limited detrimental impact on the merging firm vguppi Vertical analogue of GUPPI Moresi and Salop, Antitrust Law Review, 2013 vguppiu = value of sales diverted to downstream merging partner/revenue on volume lost by upstream merging partner vguppi = DR UD * M D * (P D / W R ) 35 Other potential effects of vertical mergers Removal of a potential entrant: Is one of the merging parties a potential competitor into the other merging party s core market? Essentially becomes a horizontal merger Key questions are likelihood and impact of entry not really a vertical issue E.g. Ticketmaster/LiveNation (DOJ, 2009) Removal of a potential entry facilitator: Is one of the merging parties a key trading partner for a potential entrant into the other merging party s core market? E.g. Ticketmaster/LiveNation (CC, 2009) Coordinated effects: E.g. Removal of disruptive force, easier sharing of sensitive information or enhanced symmetry

19 Recent UK example ICE/Trayport ICE is a clearing house and runs trading exchanges. It has a strong market position in both markets but faces significant competition in both markets. Trayport is a software supplier used by all of ICE s competitors in EU utilities trading (market share over 85%). Its platform supports the full life-cycle of a trade, from price discovery, through execution and clearing. Trayport platform is run on a closed API basis. Other software suppliers cannot connect without Trayport s permission. The need for liquidity implies network effects which make switching away from Trayport very difficult, unless everyone switches at once. (Similar liquidity network effects apply at the exchange level.) Other trading exchanges + clearing houses ICE (trading of energy derivatives) Trayport (software for traders and clearinghouses) 37 rare case of vertical foreclosure concerns Theory of harm: Pre-merger ICE has its own software Trayport is the route to market for other exchanges Post-merger, the combined entity will stop Trayport supplying traders on other exchanges (total foreclosure) or raise prices to traders seeking to access other exchanges (partial foreclosure) Largely a qualitative assessment with a quantitative cross-check Only possible remedy is divestment Trayport (software for traders and clearinghouses) 38 19

20 Conglomerate concern: GE/Honeywell GE sold engines Rivals - Rolls Royce, P&W Honeywell sold avionics Rivals - Liebherr Aircraft need both engines and avionics Merger would allow sale of a bundle as well as components Potential theory of harm mixed bundling Cut bundle price (Cournot effect) Increase component prices Rivals suffer a double whammy can t offer integrated bundle, standalone sales hit by higher mix and match prices Efficiency offence? 39 BT/EE a no-concern merger Simplifying substantially: BT is a fixed line phone operator EE is a mobile phone operator (retail and wholesale/mno) Many theories of harm considered (lots of third party submissions) In particular, key ToH was that EE would provide wholesale mobile access to MVNOs on worse terms post-merger Reduce their competitiveness with merged entity on fixed-mobile bundles (e.g. Virgin Media offers such a bundle and used EE premerger), or separately? No rival MNOs are available, and fixed-mobile bundling not necessarily key for customers, standalone options still preferred 40 20

21 1 Vertical restraints 2 Vertical (and conglomerate) mergers 3 Retail MFNs 41 Retail Price MFNs (aka price parities or best price clauses) Supplier x p x A <= p x B Supplier y Retailer A has a best price guarantee ( you won t find it any cheaper elsewhere ) Retailer A BEST PRICES GUARANTEED! End Customers Retailer B P y A <= p y B Retailer is an agent of suppliers so suppliers set retail prices subject to the best price guarantee at retail level So if Supplier x sells its product for 10 through Retailer A, it can t set a price of 9 at Retailer B Example: price comparison website Q: what happens if retailer B also has a best price guarantee? 42 21

22 Narrow and wide MFNs Retailer A is the Supplier s own distribution arm (e.g. website, supplier is an insurance company) Retailer B is a third party distributor (e.g. a price comparison website) Retailer B charges commission So: use Retailer B to publicise product, and push to Supplier s own website through lower prices Retail MFN would protect Retailer B s sales efforts and avoid free-riding Narrow MFN supplier can t undercut on own website Wide MFN supplier can t undercut on any 3 rd party website Supplier x Retailer A End Customers BEST PRICES GUARANTEED! Retailer B 43 Several cases in this area recently DGComp: E-books case Commitments agreed in July RPM banned for 2 years, MFCs banned for 5 years. CC: Private Motor Insurance Required removal of wide MFNs although narrow MFNs OK OFT/Other national competition authorities: Hotel Online Booking cases Commitments/Case closures on basis of parties dropping wide MFNs (most authorities)/any MFN (Bundeskartellamt) CMA: Digital comparison tools (opened last week!) Wide MFN in home insurance, possible breach of CA

23 Art 101: The ebooks case Retail MFN as a collusive device Apple entered the US e-book market in January 2010 Prior to Apple s entry, Amazon was selling e-books through a wholesale model, setting low prices for bestsellers ($9.99) The publishers were unhappy and got together to encourage Apple to enter, under an agency model with 5 of the major publishers. The agency model was subsequently applied to Amazon too. US DOJ sued Apple and the 5 publishers for collusive conduct in April 2012 Settled with all 5 publishers by mid-2013 Court judgment against Apple in July 2013 European Commission opened proceedings in December 2011, and issued Article 9 decision in December 2012 (except Penguin, July 2013) 45 Ebooks: Apple s retail price MFN Apple s initial proposal was that publishers must switch all other retailers (i.e. Amazon) to agency contracts too, so that publishers could set prices hard for any individual publisher to do this This request was replaced after a few days by the inclusion of a cross-model retail price MFN clause in the draft agency contracts Under this clause, each publisher had to guarantee to Apple to lower the retail price set on its platform to match the lowest price offered by any competing retailer (independently of whether the competing retailer was under a wholesale or agency model) The retail price MFN exposed the publishers to very low effective wholesale prices if Amazon were to remain on the wholesale model, thus acting as a joint commitment device to switch Amazon to the agency model 46 23

24 Impact on ebook prices: Economic evidence in the US Rarely see evidence as clear as this 47 Conclusions Lots of developments in vertical restraints cases, particularly driven by new forms of restraint in online markets Vertical and conglomerate mergers common to look at these issues (and rivals to the merged firm often raise them) but rare that they are problematic I would start with understanding the efficiency rationales first, before turning to theories of harm Regulators may disagree! 48 24

25 Frontier Economics Ltd is a member of the Frontier Economics network, which consists of two separate companies based in Europe (Frontier Economics Ltd, with offices in Brussels, Cologne, Dublin, London & Madrid) and Australia (Frontier Economics Pty Ltd, with offices in Melbourne & Sydney). Both companies are independently owned, and legal commitments entered into by one company do not impose any obligations on the other company in the network. All views expressed in this document are the views of Frontier Economics Ltd. 25