Slides - Competition Policy International

David S. Evans
University of Chicago, Global Economics Group
Elisa Mariscal
CIDE, Global Economics Group
Topic 14| Part 1
14 November 2013
Part 1
Part 2
Vertical Restraints
Profit Theorem
Procompetitive VR
Tying Theories
Anticompetitive VR
Tying Theories
Vertical Restraints Overview
Vertical Restraints Impose Conditions on the
Actions of the Buyer or Seller
Vertical restraints may be imposed.
• by the seller on the buyer or by the buyer (e.g. tying).
• by the buyer on the seller (e.g. lowest price guarantee) .
• or they may be result of negotiations between the buyer and the seller
and included in the contract between them.
They may reduce transactions costs between the buyer and seller
(procompetitive) but they could also limit competition
Common Vertical Restraints Considered by
Competition Policy
Tying and bundling: seller provides one product on condition buyer
take another product (tying) or seller provides separate products only
as a bundle (bundling).
Exclusive dealing: seller provides product only if buyer does not also
buy from rival.
Conditional rebates: price incentives conditional upon purchasing
across multiple products.
Most favored nation: seller guarantees lowest price or agrees to meet
competitor’s price.
Resale price maintenance: seller limits price buyer can resell at.
Vertical Restraints Can Involve Downstream Firm
or Final Customer
Vertical restraints between seller and final consumer (which could be
person or business).
• Telco requires purchase of both voice and Internet.
• Computer manufacturer requires purchase of computer and service
Vertical restraints between seller and downstream firm.
• Seller limits actions of reseller through for example resale price
Vertical Restraints can Involve Sale by Upstream
Firm to Downstream Firm
Firms are often part of a vertical chain
of production and distribution.
An upstream firm (Kellogg’s) might sell
its product (Cornflakes) to a
downstream retailer (Tescos) which it
sells onto consumers.
Firms often outsource inputs. For
example, Ford buys motor parts from
other companies, then sells them to
dealers who sell to consumers.
Key Competition Policy Issues
Modern competitive policy recognizes that vertical restraints
solve transaction cost problems and increase efficiency, but
Vertical restraints could be used by firms with significant market
power to harm consumers, although
The single-monopoly profit theorem shows that dominant firms
may not have the incentive to do so in some (perhaps many)
So we have to compete up with rules and analyses to
distinguish anticompetitive from procompetitive vertical
Single-Monopoly Profit Theorem
The Chicago Single Monopoly Profit Theorem
Key assumption for theorem
•Tying product and the tied product are consumed in fixed proportions such
as car and air conditioning.
•A firm has a monopoly in the tying market.
•The market for the tied product is perfectly competitive.
Chicago Single Monopoly Profit Theorem
•A monopoly in the tying product can’t increase its profit by obtaining a
monopoly in the tied product. It is already making as much as it can from the
two products.
•Consumers buy the products as a system and have a maximum amount they
are willing to pay for the system. That leads to a single profit-maximizing
price for the system. If the tied product is supplied competitively it doesn’t
make any difference whether the monopolist supplies it and bears to the
cost or lets a competitive firm supply it at cost to consumers.
Incentives to foreclose
•Firms could could have an incentive to foreclose only if the tying and tied
products are consumed in variable proportions such as photocopies and ink
© Global Economics Group. Do Not Distribute Without Permission
Illustration of Single-Monopoly Profit Theorem
Component A and B are used together (fixed proportions)
Firm has monopoly on A
Consumers willing pay by $10 for A+B
Assume cost of A and B are both $1 per unit
The most the monopolist can get is $10 and earn a profit of $8.
• $10 for AB;
• $9 for A and $1 for B (with B provided separately)
• $(10-p) for A and $p for B (with both provided together)
• $9 for A and allows competitive industry to supply B for $1
Monopolist in A’s Best Strategy is to Enable
Consumers to Get Product B at Lowest Cost
Component A and B are used together (fixed proportions).
Firm has monopoly on A.
Consumers willing pay by $10 for AB.
Assume MC of A is $1.
Assume MC of B is $3 for monopolist and $2 for a competitive
The the monopolist’s profit maximizing strategy is: Sell A for $8
and encourage a competitive industry which supplies B for $2.
Generally, if another firm could produce a component at a
lower cost than the monopolist the monopolist has an incentive
to have that firm produce.
Hilti AG v. EC Commission
Hilti made nail guns.
Hilti had a patent on cartridges for its nail guns.
Cartridges and nails were used in fixed proportions.
Hilti required customers who bought its cartridges to also buy its
Commission found Hilti guilty of tying abuse and CFI and ECJ
Single monopoly profit theorem shows no apparent possibility of
additional monopoly profit here from leveraging.
Are there any other possible theories of harm?.
Single Monopoly Profit Theorem Not
Necessarily True if Variable Proportions
Single monopoly profit theorem true only if there are fixed
proportions. If the purchases of goods A and B are in variable
proportions then the theorem does not establish impossibility of
second profit.
When the theorem does not hold it is possible that a firm could
leverage monopoly from product A to B and earn more profit.
Classic example is from Whinston who shows that it is possible
that there is a second monopoly profit if:
• Products A and B consumed in variable proportions.
• Incumbent monopolist produces A and B.
• Competitive entrant produces B.
• Scale economies in the provision of B.
• Tying A to B excludes B if enough consumers want to consume A
together with B.
“Tying” Involves Only Selling One Product with
Another Product
Contract: You must buy Product A to get Product B.
Technology: You can only get Product B integrated together with
Product A.
Price: You can get Product B much cheaper if you buy Product A.
In each case the firm is limiting the ability of the consumer to choose the
“tying good” (A) without getting the “tied good” (B) too.
European Commission Case Against Microsoft
Classic Tying Case
Microsoft provided Windows Media Player (“WMP”) as a part of
Commission complained that Microsoft was dominant in
operating systems Windows and tied a media player (WMP) to its
dominant operating system and that this was an abuse of Article
101 (then 81) TFEU.
Microsoft said that Windows Media Player was a feature of
Windows and really just one integrated product and consumers
wanted it that way.
Commission remedy was to require Microsoft to offer consumers a
version of Windows without WMP in addition to a version with WMP
so consumers would have choice. Virtually no one licensed the
version of Windows without its media player.
Tying in Practice.
Tying for Efficiency.
Tying for Price Discrimination.
Tying for Exclusion of Competitors.
Rule of Reason vs. Per Se Analysis.
Some Common Examples of Tying
Mobile phones:
• Operating system.
• Camera.
• Alarm clock.
• Shoes.
• Laces.
• Polish.
• Tires.
• Air conditioning.
• Radio.
Checking account:
• Checks.
• Debit card.
• Deposit account.
Product Design and Bundles
Basic product design questions for firms:
• What features should the firm provide or leave to other firms?.
• What “features” would some consumers like to purchase together?.
• Are there enough consumers who want that combination to make it
profitable to provide?.
Answering these questions determines:
• How many different products the firm offers.
• The features that those products have.
Better Products for Consumers
Reduces transactions costs of buying separate products (e.g. sports
news and local news).
Pays producer to make choices for the consumer (e.g., hospital
hires the anesthesiologist).
Enables products to work better together (e.g., camera and email
on phone).
Reduces search costs by preselecting choices.
Less Costly Products for Firms
Offering product involves fixed costs of packaging, stocking and
tracking (e.g. pain relievers plus decongestants).
By combining features reduces fixed costs (e.g. one distributor for
sports new and local news and everything else in newspaper).
Can average fixed costs across potentially more consumers who
want it.
Tying Complementary Products
Consumers often want to consume two products together:
• Razors and blades.
• Shoes and shoelaces.
• Operating systems and browsers, media players, etc.
Seller saves consumer time by providing together:
• Consumers don’t need to make separate purchase.
• Benefit from technical integration.
• Reduce packaging costs.
Aggregating Demand and Cost Reductions
Many products similar to supermarkets:
• No one buys all possible products.
• Supermarket selects products so most consumers can find what they
• Maximizes profit from fixed store space and staff.
Newspapers are like supermarkets:
• No one reads all stories or sections.
• Newspaper selects content so most readers can find enough value.
• Maximizes number of consumers for fixed product cost of newspaper.
Similar products include many information goods:
• Software (no one uses all features of spreadsheets).
• Web portals (no one uses all features).
Metering Demand for Durable Good
Applies to durable good used with consumable good (like
photocopier and ink cartridges).
Objective is to charge more to people who use the durable good
more—to engage in price discrimination.
Require customers to use manufacture-supplied “consumable”
and set pricing schedule for consumable so consumers who value
it most pay highest total price .
Examples include photocopies and ink cartridge; nail guns and
nails; automobiles and parts.
Bundling to Get More Consumer Surplus
“Block Booking Example” from Nobel Prize Winner George
Theatre 1
Movie Offering
Theatre 2
Maximum Price Theatre
Will Pay
Gone with the Wind
Gertie’s Garter
Change from
Cost per Movie
NOTE: Total surplus is unchanged--producers get +1000 and consumers -1000.
© Global Economics Group. Do Not Distribute Without Permission
Extending Monopoly Into Secondary Market:
Example 1
Consider monopoly hotel (for tourists) and local tennis club (for
tourists and locals) on island.
Hotel engages in strategy to extend its hotel monopoly to tennis
Hotel starts a tennis club and ties it into staying at hotel.
Incremental cost to guest of using hotel club is zero (or low).
Local tennis club loses enough customers that it can’t support
Locals must go to hotel tennis club too and so the hotel ends up
with a monopoly.
Preventing Entry into Primary Monopoly:
Example 2
Monopoly software platform provider and browser supplier.
Suppose browser could evolve into a platform.
Monopoly invests in leveraging into browser to eliminate
competition there.
Monopoly software platform ties its own browser to its platform.
Third party browser loses customers because people don’t both
installing another browser since they already have one.
Potential entrant into software platforms is eliminated.
Critical Question: Does Firm Have Incentive
and Ability to Foreclose?
Can the firm earn extra profits by tying—this could provide an
• Could it make more money by obtaining a monopoly in the tied
• Note that tying isn’t costless since if consumers prefer not to buy the
tied good from monopolist it reduces the demand and revenue for
the monopolist.
• Could it avoid losing money from having its monopoly in the primary
market eroded?.
Does the firm have the ability to foreclose?.
• Does it have enough market power to dictate choices to consumers
and foreclose enough demand from the firm in the secondary
• Can it dissuade other firms from entering the secondary market?.
The Ability to Foreclose Rivals Is Limited
Tying Must Drive Competitor in Tied Product Out.
• To earn extra profit when tying and tied product are consumed in
variable proportions the producer of the tying product must be able
to drive the producer of the tied market out and preserve the market
for itself.
• Most plausible if there are scale economies in tied product and
diversion of sales to tying firm makes it impossible for the tied firm to
attain sufficient scale.
Tied Firm Must Not Have Counter-Strategy.
• Target could lower its price to outlast the monopoly.
• Target could leverage into tying market.
Evolution of Tying From Very Bad to Usually Good
Per se violation in US starting with International Salt in 1947. Viewed
as almost always bad. But Supreme Court has moved away
gradually starting with Jefferson Parish (1984) and Illinois Tool Works
(2006). Recognizes tying is usually good.
Per se abuse under Article 101 TFEU (see Hilti (1991), TetraPak
(1994), and Microsoft (2007)). But European Commission now treats
tying more or less under rule of reason for enforcement priorities—
tying bad only if it results in significant market foreclosure.
While professional consensus is that tying is seldom anticompetitive
US and EU courts still have discretion to treat it as a per se abuse
without doing a deeper analysis.
Per Se Approach Could Prevent Good Tying
Prohibition of tying by dominant firm could prevent it from
engaging in tying that increases consumer value or reduces costs.
Therefore need a sharper test that can allow good tying to
continue but condemn bad tying when it is tried.
Rule of reason analysis allows court to consider procompetitive
features of tying as well as anticompetitive possibilities and
balance the two.
Recommended Rule of Reason Approach
Does firm have significant market power?.
• If it doesn’t it can’t force consumers to take tied product.
• If it doesn’t it can’t foreclose rivals from tied market.
Is it plausible the tying strategy could be anticompetitive?.
• Unlikely if there are fixed proportions.
Unlikely if there are no scale economies in secondary market.
If both answers are yes compare procompetitive and
anticompetitive effects.
• Examine whether it has or could likely foreclose competition and
thereby raise prices.
Examine whether there are procompetitive benefits such as higher
quality for consumers or lower prices?.
Condemn only if bad outweighs the good.
End of Part 1, Next Class Part 2
Part 1
Part 2
Vertical Restraints
Profit Theorem
Procompetitive VR
Tying Theories
Anticompetitive VR
Tying Theories

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