L11 - Vertical Relationships Case Studies

Question 1

NCM: The Market?

Answer 1

• Product market: new cars (so excludes used cars)
  
  • After-sales services are often included with the new car
• Geographic market: national sub-markets across Europe
  
  • Significant transportation costs exist between these sub-markets
  • Each tends to be characterised by a leading national brand
  • (Need for right-hand drive specification in the UK)
    
    • Costly to transport a car from one country to another so buyers tend to buy from their national market
  • Vertical relations:
    
    • Manufacturers supply franchised dealers who sell to the public
    • UK: Ford (15%), Vauxhall/Opel (13%), Renault (7%), Peugeot (7%) and VW (7%)
      
      • Manufacturers are moderately concentrated (data - 2003)
        
        • The dealer sector is highly fragmented
    • The dealers have plush show rooms, with well trained salespeople, offering important services e.g. test drives

Question 2

NCM: Regulation in the market?

Answer 2

• Prior to 1985
  
  • Article 81(1)( now 101(1) in the Europe chapter 1 in UK ) prohibited agreements, but 81(3) allowed exemptions car manufacturers needed individual exemptions for vertical agreements for each dealer they had
    
    • this was a huge burden on the manufacturers and the competition agency that had to check everyone of these
• 1985
  
  • Block exemption for car sector introduced under Reg 123/1985–> set of agreement that were said to be okay by the European Commission
  • Presumed the benefits of these agreements would outweigh the anti-competitive effects
    
    • All manufacturers could impose criteria on its dealers (selective distribution) –> raise quality of the dealers and the service they provide
    • They could appoint a single dealer in a territory (exclusive distribution) –> market power (remove intraband)
    • They could prohibit dealers from selling other brands (exclusive dealing) –> (removing Interbrand)
    • Some agreements were never legal though, namely RPM (also called black clauses)
  • Quite unregulated at this point –> no investigation is needed under these bloc exemptions
• 2002
  
  • New stricter reforms introduced under Reg 1400/2002
  • Manufacturers cannot combine selective & exclusive distribution
    
    • Most opted for selective distribution
  • The conditions on exclusive dealing are much stricter
    
    • dealers could sell up to 3 different brands of car in their dealership
    • Also these exemption didn’t apply to a firm who had a market share over a certain threshold –> had to apply for an individual exemption like before

Question 3

NCM: Exclusive Distribution: free-rider problem I?

Answer 3

• Online retailers are freer-riding
  
  • Go into a dealership, spend 2 hours helping you decide what car is best for you
  • You go away to think about it before you buy, look it up online to find another place that sells the car for half the price
• retailers would free ride on other retailers
• This free-rider problem can disincentivise firms form investing in this service and total welfare can be lower as a result
• Two dealers selling homogenous products –> Bertrand competition so P=MC=wholesale price
  
  • No incentive to invest in advertising as profits will be zero for either firm if this is the case
    
    • CS is smaller (triangle above) in comparison to advertising to increase demand
• Well what about if there was only one dealer
  
  • imagine the demand for now investment is also MR for the monopoly retailer
  • it will be produced at the exact same quantity as under two retailers but at a higher price
• So yet exclusive distribution does reduce total welfare but it also increases CS (and ergo total welfare) than under monopoly ==> this is why it was introduced
• But it became harder to do it after 2002
  
  • ​So we probably would have see prices fall due to increase in intrabrand competition
  • But an decrease in providing the good quality services

Question 4

NCM: free-rider problem and manufacturers?

Answer 4

• manufacturers free-riding off other manufacturers
• So retailers may not invest in improving the quality of the services the manufacturers may do it instead
  
  • This may be a problem if there is Interbrand competition at a dealer
  • manufacturer 1 may not reap all the benefits of its investment from the dealer and the other manufacturer is also enjoying a part of it, even though they may have not invested anything at all
    
    • The dealership is really nice, service is great happy to pay a premium on the car - but a car from manufacturer 2 instead
• Exclusive dealing removes the Interbrand competition at the dealership allowing the manufacturer to enjoy all the benefits of their investment in full

Question 5

NCM: What are the anticompetitive effect that can arise from exclusive dealing?

Answer 5

• when manufacturers are denied access to dealers
• Chicago school believe that forclosure wasn’t a problem so it wasn’t considered a problem till the regulations were re-written
  
  • This is based on the belief that buyers would not sign up to exclusive contracts that led them to being charged higher wholesale prices
• So this graph represents the upstream market where the car dealer willing to buy more units of new cars as the wholesale price falls
• Given the monopoly car manufacturer with a MC=c the retailer would buy at MR=MC if they had to an exclusive contract
  
  • Buy q^m cars at the price w^m
• What if they don’t sign up to the exclusive deal?
  
  • what would have is there would-be entrant into the market (say they sell identical cars as the incumbent)
  • price would then equal marginal cost leading the equilibrium quantity to now be higher
• CS from not signing the deal is much greater than that they would generate from signing it
  
  • Therefore to get a dealership to sign up this contract the manufacturer must compensate the dealership for the CS ) they would forgo for not signing up to it –> (the whole trapezium)
  • Given that the profit the manufacturer would back from the sale under the exclusive contract (the square) is not greater than the difference in the CS
    
    • There will not be enough profits to compensate the buyer for signing up so they won’t

Question 6

NCM: what was debated about the Chicago school theory as our understanding of exclusive dealings and foreclosures increased?

Answer 6

• As our understanding of exclusive dealings and foreclosure increase there was a problem found with the Chicagos schools analysis –> consumer would not sign up to exclusive deals and that could lead to anti-competitive effects
  
  • the manufacturer may not only sell to one dealer
  • supposing the dealers are symmetric it can generate multiple times over the profit it would make from the singular case
    
    • Can compensate some of the buyers for signing up
• Thereby the time the new entrant has grown to a sufficient scale to supply a sufficient number of the buyer in the market
  
  • They might not be able to if the manufacturer has compensated enough of the buyers for signing up to the exclusive dealing contract
• So would charge the monopoly price to all buyers only compensating some of them for signing up while other would be harmed as a result of this exclusive dealing

Question 7

THSC: What is a Hub and Spoke Cartel?

Answer 7

• Collusion facilitated is a cartel in which rival firms collude together to raise their prices
• And this collusion is facilitated by a firm that operates in a different sector of the supply chain
• In this example we will see collusion occurred between two toy retailers and that was facilitated by a toy manufacturer

retailer A say we will increase our prices for a few days in which B needs to do the same otherwise we will return them to the same level –> this is relayed through the manufacturer to retailer B who can agreed to collude and the confirmation is sent back the other way

• form
  
  • normally colluding between just the firms will raise prices and in turn affect consumers and the manufacturer (reduced quantity being sold)
  • Manufacturer instigates these (against what previously been said)
• operate
  
  • as the information hub manufacturer helps with monitoring (better information on both retailers) the agreement and dishing out punishments to the firms
    
    • If a deviation from the agreement instead of it breaking down and a price war ensues, the manufacturer can impose a punishment of not supplier that firm that did deviate
• effective
  
  • communication problems –> somethings might get lost in translation when being past through the manufacturer to each other
    
    • the hub has an incentive to distort the information they supply to each of the firms
• detected/deterred/prosecuted
  
  • communication happens between firms indirectly through vertically related firms
  • might be less likely to create suspicion because communication between retailers and manufacturers is commonplace
    
    • As retailers arent communicating directly with each other is it explicit or tacit collusion –> can they even be prosecuted
  • fines may be lower so could be less likely to deter firms for colluding

Question 8

THSC: What is in it for the Hub?

Answer 8

• A simple theory of vertically related markets suggests the manufacturer should prefer competition!
• Suppose homogeneous Bertrand downstream, so p=w
• Manufacturers (monopolists) will set w* at a monopoly mark-up over its costs
• It obtains the one monopoly profit
• Facilitating collusion downstream by raising the price of w and the retail price p?
  
  • ● fall in demand of final consumers
  • ● reduction in manufacturer’s profits
    
    • Why does the hub want to go ahead if this is the case then?
      
      • probably because the assumption of the theoretical model don’t match that of reality
• Downstream collusion causes double marginalisation!
  
  • monopoly mark up from the manufacturer and mark up from the retailer

Question 9

THSC: The Market?

Answer 9

• Product market: Toys (in UK around 2000)
  
  • Manufacturers: Hasbro, Mattel, Fisher-Price
  • Hasbro was leading toy manufacturer with brands of Action Man and Monopoly
• Firms: toys and games were sold through a variety of outlets
  
  • Specialists (Toys R Us), mixed retailers (Woolworths)
  • Catalogue retailers (Argos and Littlewoods)
    
    • Hasbro supplied large toy retailers directly and smaller ones through distributors
  • Competition –> before internet shop :
    
    • Catalogue retailers were price leaders
    • Catalogues published twice a year Spring/Summer (S/S) & Autumn/Winter (A/W)
      
      • These were the only time they could change their prices
      • Rivals could change their prices more frequently but chose to match their price to what ever was put out in the catalogue
    • The A/W catalogue was most important due to high demand at Christmas

Question 10

THSC: The Case?

Answer 10

• March 2001
  
  • Office of Fair Trading (OFT) launches investigation
  • Hasbro’s leniency application was triggered by a separate OFT investigation RPM
    
    • OFT was worried Hasbro was imposing RPM on its distributed that supplied the smaller stores
      
      • Hasbro was charging a lower price to the smaller retailers, bigger chains like Argos and Littlewoods were not happy that they were being charged a higher price so Hasbro started to increase the price to the distributors to make everyone pay the same
• November 2003
  
  • decision of OFT
  • The cartel covered A/W catalogues of 1999 and both catalogues of 2000 and 2001
  • Initially, limited to Action Man collection and its core games (including Monopoly)
  • The cartel was expanded to other Hasbro products in S/S 2000 catalogue
  • Objective was to coordinate retail prices on RRPs rather than price below them
    
    • As Argos and Littlewoods were the price leaders this then effected the prices in the whole market
• December 2004
  
  • decision of Competition Appeals Tribunal
    
    • Looked at the fines and whether this was considered explicit collusion and therefore should be considered illegal
  • CAT reduced the fines on Argos and Littlewoods to £15m and £4.5m
• October 2006
  
  • Court of Appeal upheld CAT’s decision Argos and Littlewoods appealed as no communications between the two retailers
  • Court of Appeal: conduct reduced uncertainty over rivals’ pricing intentions

Question 11

THSC: Key Features of the Cartel?

Formation

Answer 11

• Retailers were “unhappy with the margins … on Hasbro’s branded products”
  
  • Price competition at the retail level was very intense
• Hasbro concerned product would be delisted
  
  • Unlike theory Hasbro isn’t a monopoly and can to compete with other toy manufacturers :
  • ​Didnt bother lower wholesale price to improve margins as it can be assumed competition was so fierce p=MC and the margins wouldn’t change
    
    • Developed the “pricing initiative” was for retailers to charge the RRP
• “Argos and Littlewoods were key … since they were the market leaders”
• Hasbro engaged in bilateral communications with Argos and Littlewoods

Question 12

THSC: Key Features of the Cartel?

Coordination

Answer 12

• “no evidence that Argos and Littlewoods spoke directly”
• “confidential information was exchanged between them with Hasbro acting as the fixer or middleman.”
• Retailers informed Hasbro which products would be at RRP and which wouldn’t be ; Hasbro passed it on

Question 13

THSC: Key Features of the Cartel?

Monitoring and Punishment

Answer 13

• No evidence the hub was involved in the punishment side
• Retailers would threaten each other with price wars:
  
  • If undercut, Littlewoods would “serious price cutting” in the next catalogue
• Argos and Littlewoods monitored each other (and other rivals)
• When rivals weren’t at RRP, they informed Hasbro to sort out to avoid a price war

Question 14

THSC: Key Features of the Cartel?

Effectiveness

Answer 14

• the collusion was evident even if Argos and Littlewoods didn’t speak directly