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Economic Modeling - Antitrust Economics
Introduction
Vertical integration involves the relationship between suppliers and manufacturers, or
retailers and their suppliers. Complex yet succinct contractual provisions are referred
to as vertical constraints within the economics realm, which bind the relationship
components. The constraints’ effect goes beyond the simple market wholesale prices
to specific terms that guide the stipulations of payments as well as the contractual
party’s conduct. There are various vertical constraints such as the maximum retail
price maintenance, exclusive distribution, exclusive territories, and the exclusion or
foreclosure of a certain retailer. All the contractual provisions have an ultimate goal
of creating an advantage to either or both parties involved. As such, the restrictive
factors end to a common conclusion that sets up an antitrust firm wielding
monopolistic control over the market. Unlike the other constraints, the resale price
maintenance has a direct impact on the behavior of both contracting parties. However,
it imposes the decision on the final retailer price to the supplier.
Effects of Resale Retail Maintenance Price
There has been a raging debate over the controversial policy framework that would
solve the inconsistency in regulating the restraints between the downstream retailers
and their upstream suppliers. The resale price maintenance has various variants that
include price floors, price ceilings and advertised or non-binding retail prices that
have been overexploited to impose costly switch or entry costs. Due to challenging
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enforcement, the restriction pre-supposes that it would be possible to detect price cuts
including non-monetary concessions downstream with a charge of minimum cost. The
incurred cost would be the coordinated punishment strategy imposed on the deviating
party. Nevertheless, the upstream supplier has an upper hand and may take advantage
of the asymmetric information sharing. Through vertical integration, the supplier
would engage a retailer’s rival through a lower marginal price and cushion it against
the incumbent’s competitive advantage. Increasing the rival retailer’s profit margin,
after which the supplying firm would take some share out of it, motivates the supplier.
Although the legal fraternity partially agrees that resale retail maintenance is
strictly anticompetitive, the economists’ views on the RPM remain vague. The
economic analysis indicates that despite the fact that the resale price management
leads to monopoly it also results to significant advantages that enhance production
and market efficiency. However, assuming that the market lacks double
marginalization, discounts and quality certification the RPM relationships would
remain a harsh restriction to competition. With resale retail maintenance, the retailer’s
profit would not be determined by the wholesale prices offered to the competitors. As
such, the supplier would be at liberty to advocate for higher prices through vertical
integration to earn increased profits.
Typically, RPM or the resale retail maintenance restraint negatively has
potential effects on fair competition. It has far reaching implications not only on interbrand but also the intra-brand market related competition. Due to the extensive
damage on the competition, the vertical restraint causes price increase on both the
wholesale and retail segments. As such, innovation efforts or quality and the choice of
offer are drastically reduced. Over the years, the vertical restraint has been used as
barrier to expansion and entry of market competitors. Through exclusive deals, the
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resale retail maintenance raises the costs of operation in particular markets. Emerging
potential competitors are relegated to weaker participants bearing huge financial
profit challenges. In case of a strong and competitively advantaged supplier operating
as a monopoly, market entry could be denied through price parity where by the firm
charges lower prices.
Resale retail maintenance price facilitates the dominance of implicit or explicit
collusion. The concealed vertical distribution system poses difficulty in monitoring
the supplier’s selling price. Once retailers are tied up in vertical resale retail
maintenance, the supplier price reduction incentives are curtailed. As a fact, the
supplier could not adjust within the constrained and pre-determined profits. RPM
stabilizes collusion through interlocking the supplier-retailer relationship thereby
diminishing the end consumer’s power. The supplier would only be concerned with
maximizing profits by either raising the maximum resale retail price or setting a price
floor. The incumbent firm transfers some of these super profits to the retailers making
them hard to contract new suppliers. The retailers remain tied to maintaining their rent
streams that would be reduced by engaging a new supplier.
In case of retailers with strong buyer power, RPM remains anti-competitive
due to intensive intra-brand rivalry. It follows that the retailers would then be highly
substitutable in the presence of RPM. In spite of their strong negotiation power, the
retailers would be restricted against bargaining for reduced wholesale prices. Supplier
would be able to impose fixed price floor making the retailers unable to increase
market share as a result of the reduced prices. The end consumer pays high retail price
that reduces its welfare transferred through the retailer to the supplier. As such the
consumers are worse off with the RPM even with the total elimination of the intrabrand competition.
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Economic Modeling
Through assumption, a market has two suppliers M and H but without requisite
bargaining power. The market also has two retailers D and G. However retailer D
remains more efficient and valuable in the economy than retailer G. Analyzing the
impact of RPM whereby the competing upstream suppliers sell their products to
Retailer D1, a downstream monopolist and a weak retailer G.
D1 has the buyer power and as such enjoys zero intra-brand rivalry.
Thus
Denotes the magnitude of the intra-brand rivalry
Only remain to vary
No intra-band rivalry
Supplier M
Supplier H
WMD
WHD
Retailer D
The demands become
= 1-
-
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= 1-
-
, Denotes the level of similarity of the products produced by both supplier M and
supplier H
When setting its RPM, supplier M should consider how the changes in its RPM price
would affect its revenue from quantity it sales for a given whole sale price.
Thus,
/
) = Competition effect
It should also consider the effect on its wholesale price that it would be able to
negotiate for any quantity
Thus, (
= Surplus sharing effect
Therefore, in an effort to balance its operation, firm M has two strategies. It could
either reduce its price to increase the quantity sold so as to increase its profit or it
could increase its price to raise the negotiable wholesale price. Increasing the
wholesale price would result to higher RPM that would preserve the joint surplus it
shares with the retailer D. As such, supplier M would concentrate more to the surplus
sharing effect when it projects its future wholesale prices to be low coupled with
extensive pressure to lower it downwards.
If the D’s power to negotiate,
= 1, the supplier M’s wholesale price, WMD = 0
The impact on its profit due to change in RPM would thus be,
=(
/
)
As such firm M’s RPM indicates that it will be adjusted to maximize the joint
profit.
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The supplier would only accept the vertical integration as long as there is an
increase in the accruing profits. In this case, supplier M would be more concerned in
getting a share of the super profits resulting from the increased retail profits.
Thus RPM= {(
-
) 1- (
) }-1
Whereby superscript denotes the retailer D’s bargaining power
(
(
-
) 1- = the supplier M gain from the trade
)
= the retailer D gain from the trade
Due to the maximization of the resale retail maintenance price, the product would be
sold at a higher price. In this case, the consumer suffers more harm as the retailer and
the supplier make more profits.
Conclusion
In conclusion, vertical integration results from contractual provisions broadly known
as constraints. Legal experts assert that the constraints lead to strict monopolies in the
market. Economists provide contentious opinion postulating that constrains harbor
benefits besides the anti-competition restriction. Some of the vertical constraints
include resale retail maintenance price, exclusivity both on distribution and territory
as well as foreclosure or exclusion of particular retailers. The RPM yields direct effect
on both the retailer and the supplier, as it affects not only the wholesale price but also
the buyer bargaining power. The RPM restricts entry of potential retailers through
price variations. It abets collusion among the market segments leading to price hikes
that affect the end consumer. Once the retailer wields the negotiating power, the
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supplier would have to adjust the wholesale price to leverage loss of profits.
Maximizing the RPM would ensure the joint profits are optimized.