Vertical Foreclosure Using Exclusivity Clauses: Evidence from Shopping Malls∗ Itai Ater Tel Aviv University March 9, 2014 Abstract Exclusive contracts are one of the most controversial topics in the economic analysis of antitrust. Yet, very few empirical papers analyze the determinants and the consequences of exclusive contracts. In this paper, I study exclusive contracts between hamburger restaurants and Israeli shopping malls, in which mall owners commit to prohibiting additional hamburger restaurants from entering their malls. I investigate the determinants of these exclusive contracts and examine how such contracts affect the number of hamburger restaurants and their sales. I show that exclusive contracts are less likely to be adopted in larger malls, in malls that face more competition from other malls, and in malls that opened before 1993, when McDonald’s and Burger King entered the Israeli market. I then use the mall’s opening year - before or after 1993 - as an instrumental variable to estimate a negative effect of exclusive contracts on the number of restaurants and on total mall hamburger sales. My findings are generally consistent with anti-competitive vertical foreclosure models. ∗ This paper is a revised chapter of my PhD dissertation. I am thankful to the co-editor and two anonymous reviewers for very helpful suggestions. I also received helpful comments from Ran Abramitzky, Assaf Eilat, Liran Einav, David Genesove, Nadav Levy, Massimo Motta, Peter Reiss, Oren Rigbi, Ilya Segal, Yossi Spiegel and Yaron Yehezkel. Nadav Anin provided excellent research assistance. I thank the Falk Institute for Economic Research in Israel for financial support. Any remaining errors are my own. 1 JEL classification: K21; L42 Keywords: vertical restraints; exclusive dealing; shopping malls; antitrust; foreclosure 1 Introduction The justifications for and consequences of exclusivity arrangements, whereby one firm limits its freedom to deal with other firms, are among the most contentious issues in the economic analysis of antitrust. Theoretical models have shown that such arrangements can be efficiencyenhancing or can be an anticompetitive means to foreclose rivals. Given the controversial nature of exclusivity arrangements, it is not surprising that these arrangements are featured in many prominent antitrust cases. Microsoft, for example, was accused of requiring computer manufacturers to exclude Netscape’s web browser in favor of Microsoft’s Internet Explorer browser. More recently, Intel was accused of using exclusive dealing to reduce competition with its main rival AMD, and various allegations have been raised concerning the impact of the exclusive distribution of Apple’s iPhone by AT&T. Closely related to this study are the new guidelines published by the UK Office of Fair Trade regarding the application of competition law in the context of land agreements as well as recent decisions by the Australian and the South African competition authorities.1 Due to the limited availability of micro-level data on exclusive contracts, very few empirical papers study the sources and the consequences of these arrangements. Whinston (2006) writes: “Empirical evidence on the motives and effects of exclusive contracting is remarkably limited... formal statistical studies of market data are rare.” This paper aims to start filling this gap by investigating the determinants and the effects of exclusivity clauses made between owners of Israeli shopping malls and hamburger chain restaurants located in those malls. In particular, the contracts I study prohibit the owner of the shopping mall from leasing space to 1 See http://www.oft.gov.uk/OFTwork/policy/land-agreements, http://www.accc.gov.au/ media-release/supermarket-agreement-opens-way-for-more-competition, http://www.compcom.co. za/assets/Uploads/AttachedFiles/MyDocuments/Competition-News-Edition-41-Dec-2011.pdf. For a discussion on how the Federal Trade Commission handled exclusive dealing clauses in malls, see Clarkson and Muris (1981) and also Judge Posner’s opinion in Walgreens Co. V. Sara Creek Property Co., 966 F.2d 273, 274 (7th Circuit 1992). 2 other hamburger restaurants. My analysis draws from theoretical papers on vertical foreclosure, defined as: “A dominant firm’s denial of proper access to an essential good it produces, with the intent of extending monopoly power from that segment of the market (the bottleneck segment) to an adjacent segment (the potentially competitive segment)” (Rey and Tirole (2007)). To motivate the empirical analysis, in Section 2 I develop testable hypotheses which I later test in the data. The first set of hypotheses focuses on the private incentives to adopt exclusive contracts. The first hypothesis is based on the idea that when competition between restaurants in a mall is stronger – that is, when two restaurants are more likely to cannibalize each other’s sales – the mall and restaurants in the mall have greater incentives to adopt exclusivity clauses (Whinston (2006)). Correspondingly, I hypothesize that exclusivity clauses are more likely to be adopted in small malls, where the competition between restaurants is stronger than in larger malls. The second hypothesis is that exclusivity arrangements are less likely to be adopted in malls that face stronger competition from other malls. The intuition is that restaurants will have lower incentives to foreclose their rivals from a given mall when these rivals can find alternative distribution channels, i.e., through nearby malls (Krattenmaker and Salop (1986)). I find support for both hypotheses in the data. A second set of hypotheses concerns the effects of exclusivity clauses both on the number of hamburger restaurants and on the sales of hamburger restaurants in a given mall. According to foreclosure models (e.g., Hart and Tirole (1990)) exclusive contracts limit the number of firms (i.e., hamburger restaurants) in the market (i.e., shopping mall) and, as a result, negatively affect competition and total sales in the market. The effect on total sales is important because it is sometimes used to assess the social costs of exclusive contracts (Lafontaine and Slade (2008)). To illustrate the relationship between exclusive contracts, the number of mall hamburger restaurants and total mall hamburger sales, Figure 1 presents the annual total sales of hamburger restaurants in Israeli malls in 2002 as a function of the number of stores in the malls in which they are located. The figure shows that malls with more stores have higher total hamburger sales and are less likely to adopt exclusive contracts. 3 More importantly, it shows that, conditional on the number of stores in each mall, malls that sign exclusivity agreements with hamburger chains contain, on average, fewer hamburger restaurants, and that the total hamburger sales in these malls are lower, as compared with malls without such agreements. This suggests that exclusivity contracts negatively affect total mall hamburger sales through their impact on the number of hamburger restaurants in the mall. This empirical relationship, however, cannot be interpreted as causal; for example, it may simply reflect a tendency for malls with low hamburger demand to adopt exclusivity contracts. To estimate the impact of exclusive dealing clauses on sales, it is necessary to identify an exogenous source of variation in the decision to incorporate an exclusivity clause into the lease agreement. Such a determinant of exclusivity clause should affect the decision to include an exclusivity clause in the lease agreement while not having a direct effect on the sales of hamburger restaurants. I take advantage of the unexpected entry of McDonald’s and BurgerKing into the Israeli market, turning the local hamburger chain market into an oligopoly. Before 1993, the incumbent hamburger chain in Israel, BurgeRanch, was virtually the only national chain, and the lease agreements in malls where it operated did not include exclusivity clauses. In late 1993 and early 1994, respectively, McDonald’s and Burger King entered the Israeli market. Following their entry, hamburger chains began competing to secure attractive locations for their restaurants and incorporating exclusivity clauses into their lease agreements. Thus, I exploit the variation in shopping mall opening dates, before versus after 1993, to investigate the effect of exclusivity clauses on the number of hamburger restaurants in a given mall and consequently on hamburger restaurants’ sales. My estimates suggest that exclusivity clauses have a sizable negative effect on the number of hamburger restaurants and thus also negatively affect total mall hamburger sales. The restriction implied by the instrumental variable estimation is that, conditional on the controls included in the regression, the mall opening date has no effect on the number of hamburger restaurants or on the sales by hamburger restaurants in 2002, aside from its effect on the decision to adopt exclusivity clauses. This restriction is threatened if the year the mall 4 was opened is correlated with the demand for hamburgers in the mall. Such correlation might occur, for instance, if malls that opened before 1993 were able to secure better locations and hence in 2002 were still able attract more customers compared with malls that opened after 1993. In section 4.3 I describe several strategies that mitigate this concern. For instance, I check that the age of the mall has no predictive power with regard to the sales of hamburger restaurants in the mall. In addition, using sales data from apparel stores located in the same malls, I show that malls that opened before the entry of the international hamburger chains in 1993 do not have higher sales than malls that opened after 1993. There is very little empirical evidence on exclusive agreements in general or on vertical foreclosure in particular. Rey and Tirole (2007) write: “We are aware of few empirical studies of modern foreclosure theory. Needless to say, this is an area that would deserve further investigation.” The studies that do provide some support for foreclosure theory investigate instances of full integration between upstream and downstream firms. Chipty (2001) investigates vertical integration decisions in the cable industry; she shows that integrated cable operators exclude rival channels but also charge lower prices. Suzuki (2009) performs an event-study analysis of the merger between Time Warner and Turner Broadcasting and finds some evidence of foreclosure. Martin, Normann and Snyder (2001) test the theory on vertical foreclosure using experimental techniques and find partial support for it. The empirical studies that investigate the role of exclusive dealing rather than full integration focus primarily on the beer industry and do not find evidence consistent with foreclosure theory.2 Asker (2005) analyzes the effect of exclusive distribution arrangements on the Chicago beer market and does not find evidence of foreclosure. Sass (2005) uses a detailed survey of the cost structure of 391 beer distributors to show that exclusive dealing increases the productivity of the sales and promotional efforts of distributors. More generally, two surveys of the empirical literature on vertical restraints (Lafontaine and Slade (2008) and Cooper, Froeb, O’Brien and Vita (2005)) conclude that the overall empirical evidence indicates that vertical restraints have positive welfare effects, and 2 See, however, also recent studies by Nurski and Verboven (2013) and Bar-Isaac and Gavvazza (2013) who study the role of exclusive contracts in the European car market and in Manhattan real-estate market, respectively. It is also worth noting that previous empirical studies have generally not focused on settings in which a dominant firm denies access to an essential good it produces. 5 that there is no one paper that unambiguously shows that the use of vertical restraints leads to lower total output and reduced welfare. Finally, this study is also related to the literature on two-sided markets, of which shopping malls are a prime example. To my knowledge, this literature has not considered exclusive arrangements in which the platform itself commits to not allowing other firms to join the platform.3 The remainder of the paper is organized as follows. In Section 2 I develop the testable hypotheses as drawn from the theoretical literature. In Section 3 I describe the Israeli shopping mall and hamburger chain markets and the data used in the empirical analysis. In Section 4 I present the estimation results for the determinants and effects of exclusivity. Section 5 discusses the results, and Section 6 concludes. 2 Theoretical background and testable hypotheses Exclusive agreements between retailers and shopping malls imply that mall owners are prohibited from leasing space in their malls to competing retailers. Such agreements raise antitrust concerns, since they may foreclose entry and limit competition in a given mall. Yet, it is often argued that exclusive agreements can help firms organize their distribution more efficiently or encourage investments (see Telser (1960) and Marvel (1982) for early works that emphasize efficiency rationales for exclusive contracts). In such cases, where these agreements result in cost reduction or some other efficiency dividend, antitrust concerns may be unfounded. A common theme in theoretical foreclosure models is the idea that adversely affected parties are absent at the contracting stage. Whinston (2006) points out that these foreclosure models can be broadly divided into two main classes. The first class of models, which is more relevant to this study, considers competition among firms to sign exclusive contracts while other parties such as future customers do not participate in the contracting stage (Bernheim and Whinston (1998), hereafter ‘BW’). Whinston (2006) also makes the point that under certain conditions the BW framework can incorporate vertical foreclosure models (Hart and Tirole 3 Another related strand of literature concerns the debate over the growth (encroachment) strategies adopted by U.S. franchisors (see Kalnins (2004)). 6 (1990)). The second class of models (e.g., Aghion and Bolton (1987), Rasmusen, Ramseyer and Wiley (1991)) considers situations in which the buyer and the seller bargain over exclusivity while a rival buyer/seller is absent. In these models an incumbent firm enjoys a first-mover advantage which leads to the adoption of exclusive contracts that prevent the entry of rival firms. The BW framework implies that exclusive contracts maximize the joint surplus of the contracting parties, potentially at the expense of parties who are not involved in the contracting process – in this case, mall customers. In particular, under this framework an exclusive contract between a mall owner and a retailer will be adopted only if it effectively limits the competition between downstream retailers, enabling the mall owner to extract higher rents from the restaurant that operates under an exclusivity contract. In other words, if the exclusive contract does not affect competition in the downstream market, then retailers have no reason to pay for it. Whinston (2006) emphasizes this point by showing that exclusivity contracts will be adopted when downstream retailers are undifferentiated (assuming multiple retailers are in the market), whereas they are less likely to be adopted when retailers are differentiated.4 I follow Whinston (2006) and assume that the size of the mall provides a measure for the level of differentiation across hamburger restaurants in the mall. The differentiation stemming from the size of the mall is supplementary to the inherent differentiation that exists among hamburger chains. Differentiation in larger malls can be driven either by the ability to locate hamburger restaurants at distant locations from one another, or by the heterogeneity in the tastes of the population that a larger mall serves, some preferring one hamburger chain over the other. Indeed, in my data large malls often have more than one food-court and locate hamburger restaurants in different areas in the mall. Furthermore, in most Israeli malls in which multiple hamburger chains operate, some restaurants offer kosher food and some offer 4 The theoretical literature (Marx and Shaffer (2007) and Miklos-Thal, Rey and Verge (2011)) has also shown that upstream firms are likely to establish exclusive contracts when they cannot sign rich enough contracts that would sustain or replicate the vertically integrated outcome, i.e., combine the benefits of differentiation with those of avoiding rent dissipation caused by downstream competition. This requirement seems to fit the simple revenue-sharing type of contract that is common in the shopping mall industry. 7 non-kosher food.5 Thus, drawing from the theoretical literature (Whinston (2006)), exclusive contracts between malls and hamburger restaurants are less cost-effective in larger malls and therefore are less likely to be adopted in these malls.6 Thus, the first testable hypothesis that I examine is: Hypothesis 1 Consistent with foreclosure models, exclusivity clauses between malls and hamburger restaurants are less likely to be adopted in larger malls. The theoretical literature on market foreclosure has also emphasized that exclusive arrangements may be used to raise rival firms’ costs (e.g. Krattenmaker and Salop (1986)). According to this argument, retail chains (e.g., McDonald’s) invest in exclusive relationships with malls in order to raise the costs that competing chains (e.g., Burger King) incur in order to gain access to customers. Following this reasoning, I hypothesize that chains will find it less profitable to invest in such exclusionary practices when alternative distribution channels, such as nearby malls, are available.7 Thus, I empirically test the following:8 Hypothesis 2 Consistent with foreclosure models, exclusivity clauses are less likely to be adopted in malls that face stronger competition from nearby malls. The literature on vertical foreclosure has emphasized the role of commitment by an upstream monopoly as a means to foreclose rivals from the downstream market (Hart and Tirole (1990)). The central idea in the commitment literature is that downstream firms are concerned that 5 The same restaurant cannot offer both kosher and non-kosher food. Furthermore, kosher restaurants typically sell to a large base of customers but are closed on weekends. 6 A formal theoretical model developed in appendix A further shows that exclusive contracts are less likely to be adopted in larger malls. 7 A similar prediction can be derived by focusing on the incentives of malls to grant exclusivity. A mall’s success depends on the mix of mall stores, which, in turn, affects the number of customers patronizing the mall and the payments the mall owner receives from the retailers at the mall. When contemplating whether to sign an exclusive contract with a particular hamburger chain, mall owners evaluate the additional payment they can receive from that chain in return for exclusivity, and balance it against the costs of disrupting the optimal mix of mall stores by choosing to have only one hamburger chain in the mall. As the number of competing malls rises, the costs associated with choosing a non-optimal mix of mall stores increase, making the exclusive contract less appealing for the mall. 8 A different prediction could potentially be derived from efficiency-enhancing models of exclusive contracts. These models often stress that exclusive contracts are used to strengthen inter-brand competition (i.e., competition between malls) and therefore exclusive arrangements are arguably more likely to be adopted by malls that face strong competition from nearby malls. 8 the upstream monopoly will jeopardize their dominant position in the downstream market by supplying inputs to other downstream rivals. Consequently, a downstream firm will be unwilling to pay high payments to an upstream firm unless the latter commits – through exclusive contracts – not to sell to rival firms. To test the commitment argument, an exogenous change in the threat of entry by hamburger chains into malls is needed. I exploit the unexpected entry of McDonald’s (October 1993) and Burger King (January 1994) into the Israeli market as an exogenous variation in the threat of entry faced by BurgeRanch, which until 1993 was the only national hamburger chain in Israel.9 Accordingly, following Hart and Tirole (1990) I test the following:10 Hypothesis 3 Consistent with foreclosure models, exclusivity clauses are more likely to be adopted by malls that opened after 1993 than by malls that opened before 1993, when the Israeli hamburger retail market was dominated by one chain. Exclusive contracts between malls and hamburger chains prohibit the opening of restaurants operated by other chains. Under certain conditions, a chain that signs an exclusive contract with a given mall may choose to operate multiple restaurants in that mall, making the total number of hamburger restaurants in the mall the same as it would have been without an exclusive contract. However, the likelihood of an incumbent chain opening an additional restaurant in a given mall is probably lower than the likelihood of a rival chain entering a mall (that does not operate under an exclusivity clause). This is because each additional restaurant cannibalizes the sales of existing restaurants; while the incumbent chain considers the business-stealing effect when it contemplates opening a new restaurant, rival chains (that do not currently operate in the mall) do not. Thus, based on this reasoning, I predict that: 9 In section 3.1 I provide more details on this change in market structure. There are two main reasons why renegotiation by BurgeRanch and malls opened before 1993 rarely took place after McDonald’s and Burger King announced their entry. First, adopting an exclusivity clause is often used to attract anchor tenants, such as hamburger chains, in the early stages of a mall development project. Once the entry cost was considered sunk, it was much harder for the chain to bargain. In addition, the length of the lease contracts, typically 5 years, introduced some rigidity in changing the terms of the lease. 10 In contrast to foreclosure models, models that emphasize the efficiency gains from operating through an exclusive retailer could suggest that because the exclusive relationship is beneficial for both the mall and the exclusive retailer, shopping malls will continue to operate with only one retailer also after 1993. 9 Hypothesis 4 Fewer hamburger restaurants operate in malls that adopt exclusive contracts. The next two hypotheses concern the impact of exclusivity contracts on hamburger sales at the mall and at the restaurant levels. Focusing on the effect of exclusivity contracts on sales at the market (mall) level is important because previous studies have considered this effect to be a reflection of the effect of exclusivity contracts on consumer surplus (see the survey by Lafontaine and Slade (2008)). Generally, foreclosure theories imply that the total quantity sold should be lower in the presence of exclusive contracts because a retailer that operates under exclusivity faces no competition and hence can charge a higher price or offer lower service quality (e.g., shorter opening hours, slower service or lower hygienic quality) than when it faces competition (e.g., Hart and Tirole (1990), Bernheim and Whinston (1998)).11 When downstream retailers offer differentiated goods total sales are further expected to be lower because the adoption of exclusive contracts limits the variety that customers are offered (e.g., Kuhn and Vives (1999)).12 In the current study, the effects of exclusive contracts on quantity sold will be a result of product differentiation or lower quality rather than a result of price differences. This is because items at Israeli hamburger restaurant chains are priced similarly across all the chain restaurants regardless of whether these restaurants operate under exclusive contracts. Accordingly, I empirically examine the following: Hypothesis 5 Consistent with foreclosure models, exclusive contracts negatively affects total mall hamburger sales. It is also useful to consider the effect of exclusive contracts on the sales of an individual restaurant. According to models that emphasize efficiency rationales for exclusive contracts, restaurants that operate under exclusive contracts will sell more than restaurants that do not operate under exclusive contracts for two reasons. First, according to these models, restaurants 11 The commitment to limit competition in the downstream market enables the upstream firm (i.e., the mall) to extract higher payments from the retailer that operates under exclusivity. As further explained in the theoretical model in appendix A, mall owners will agree to sign an exclusivity clause with a hamburger chain if the payment they receive for the exclusivity clause plus the rent from the retailer who uses the ”freed” space in the mall are higher than the additional rents the mall owners would have received from a second hamburger restaurant. 12 In contrast to foreclosure models, efficiency-based models are ambiguous regarding the effect of exclusive contracts on total sales. This ambiguity occurs because the efficiency gained by restaurants that operate under exclusive contracts might lead to higher total sales and thus compensate for higher prices or for the reduced variety offered to mall customers. 10 that operate under exclusive contracts have some efficiency advantage over restaurants that do not have exclusive clauses built into their contracts. This advantage (e.g., higher returns to advertising) may translate into higher sales by individual restaurants. Second, restaurants that operate under exclusive contracts have a dominant position in the mall, which is also likely to increase their sales in comparison to restaurants that do not operate under exclusive contracts, especially when prices are similar across restaurants regardless of whether they operate under exclusive contracts.13 Based on the above arguments, I test the following: Hypothesis 6 Consistent with efficiency-based models of exclusive contracts, there exists a positive relationship between exclusive contracts and sales at the restaurant level. 3 Industry background, data and descriptive statistics 3.1 Industry background In 2002, 75 malls were operating in Israel and 68 of these malls contained at least one hamburger restaurant.14 Mall ownership in Israel was distributed across several companies in 2002. The largest of these companies had stakes in seven malls, with most other companies owning only one mall each. The typical rent structure for tenants in a shopping mall was either a fixed base rent or a fixed share of the monthly revenue, whichever was higher. In successful shopping malls, the latter revenue share was usually below 10%. Lease contracts typically covered a period of 5-10 years; furthermore, tenants typically had an option to renew their leases, sometimes for up to 22 years, if they met certain conditions. For many Israeli retail industries, shopping malls are considered a prime location. Three national hamburger chains were operating in 2002 in Israel: McDonald’s with 108 restaurants (44% of restaurants) and a market revenue share of 51%; BurgeRanch with 83 13 In contrast to efficiency-based models for exclusive contracts, foreclosure models are unclear with respect to the effect of exclusive contracts on sales by individual restaurants. On the one hand, restaurants that operate under exclusive contracts do not face rivalry in the mall and hence will sell more. On the other hand, even if prices are unchanged under exclusive contracts, these restaurants may reduce their service quality. Thus, overall, the adoption of exclusivity clauses will not necessarily lead to higher sales by individual restaurants. 14 The market description is based on the Antitrust Authority’s decision in 2002 to block the merger between Burger King and BurgeRanch, in addition to information on the chains’ web sites, media coverage, and information gathered from conversations with chain and shopping mall directors. 11 restaurants (33% of restaurants) and a 28% market revenue share; and Burger King, with 56 restaurants (23% of restaurants) and a 21% market revenue share. McDonald’s was considered the dominant firm in 2002, and its average sales per restaurant were higher than those of the other chains. McDonald’s was generally more popular than the other chains among average consumers and among children. Burger King and BurgeRanch fared somewhat better among young males and more kosher-oriented customers, respectively. Each chain invested nationally in advertising and product development. McDonald’s and Burger King entered the Israeli market in 1993 and in 1994, respectively, following developments in the peace process and the relaxation of the Arab boycott of Israel in the early 1990s (Fershtman and Gandal (1998)). Prior to their entry, BurgeRanch, which had 44 restaurants in 1994, was the only national hamburger chain to open restaurants in Israeli malls. Since 1994, the number of chain-affiliated restaurants has increased rapidly. A main driver for this rise was the wave of new shopping malls that were opened in Israel since 1986 (when the first shopping mall in its typical form was established). In recent years Burger King and BurgeRanch have faced considerable difficulties and entered bankruptcy procedures in 2003 and 2008, respectively. Lease agreements among hamburger chains and malls were negotiated on a case-by-case basis between the malls and the local headquarters of the chains. All hamburger restaurants that were located in the malls were operated by the respective chain and following the standards of the chain. In particular, prices for each chain were set by the chain’s headquarters and were identical across all of the chain’s restaurants. In addition, prices across the different chains were roughly similar for the main products. For example, the standard meals in McDonald’s and BurgeRanch were priced similarly in 2002. 3.2 Data The following information was available for the 68 malls that contained at least one hamburger restaurant in 2002: mall size (in m2 ), total number of stores in the mall, ownership of the mall, mall type (enclosed or unenclosed mall), mall opening date, and whether exclusivity clauses 12 were included in the lease agreement between the hamburger chain and the mall.15 I also obtained restaurant-level sales data for all Burger King and BurgeRanch restaurants.16 Out of the 68 malls in my data, 44 contained at least one restaurant operated by one of these chains. For the remaining 24 malls - in which McDonald’s operated as the only hamburger chain - no hamburger sales data were available. The data for the latter malls were used to study the decision to adopt exclusivity and to determine the competitive environment of malls. For each of the 44 malls for which some sales data were available, I used the sales data to construct a measure of the total hamburger sales in the mall. If sales data were available for all hamburger restaurants operating in a particular mall, I was able to calculate the actual aggregate hamburger sales in the mall. In 11 out of the 44 malls, a McDonald’s restaurant was operating together with either Burger King or BurgeRanch; in each of these cases, I assumed that the McDonald’s restaurant sales were the average of the sales of the other hamburger restaurants in the mall. A measure of total mall hamburger sales could then be derived.17 3.3 Descriptive statistics Table 1 lists descriptive statistics for annual sales and rent of Burger King restaurants in addition to information on the annual sales of BurgeRanch restaurants. The figures are in thousand Israeli shekels (1 dollar ≈ 4 shekels). As can be seen in the table, the average sales at hamburger restaurants located in malls are significantly higher than the corresponding sales at non-mall locations. Table 2 provides descriptive statistics for mall characteristics, distinguishing between malls in which each hamburger chain operates under exclusive contract and malls in which no exclusive contract is adopted. In roughly 80% of the malls, a hamburger 15 Data on hamburger restaurant locations came from the chains’ web sites and their headquarters. Additional data on the existence of exclusivity clauses, mall opening dates, and the identities of mall landlords were obtained from chains’ websites, the Israeli Antitrust Authority, shopping mall directors, and media coverage over the years. 16 These data were obtained from BurgeRanch and from a potential acquirer of the Burger King franchise in Israel after its bankruptcy in 2003. 17 The derived total sales measure for these malls is likely to be a low estimate of the actual mall total hamburger sales because (based on the aggregate chain data mentioned above) McDonald’s restaurants typically generate higher sales compared with restaurants of the other chains. Using higher estimates of McDonald’s restaurant sales (or actual measures of McDonald’s sales, had they been available) would only strengthen my results concerning the distinction between malls with and without exclusivity. In a separate analysis described in section 4.3, I verify that my results are robust to changes in the assumption regarding the sales of McDonald’s restaurants relative to the sales of the other chains. 13 chain operates under exclusivity. Consistent with hypotheses 1 and 2, malls that do not adopt exclusive contracts with hamburger chains are considerably larger (as measured by both their size and the number of stores) and are typically located closer to other malls. Furthermore, consistent with hypothesis 4, more restaurants operate in malls that did not establish exclusive contracts with hamburger restaurants. This latter finding arises despite the fact that in some cases, a chain that adopted an exclusivity clause with the mall owner operates multiple restaurants in that mall. Finally, exclusive contracts are more common among malls that opened after 1993, when the Israeli hamburger chain market became an oligopoly. In particular, the lease agreements of hamburger restaurants in 7 of the 15 malls that had opened before 1993 included exclusivity clauses. In contrast, the lease agreements of hamburger restaurants in 46 of the 53 malls that opened after 1993 included an exclusivity clause. Panel A in Table 3 presents further evidence on the negative relationship between the existence of exclusive contracts in the lease agreements and mall size. Malls are divided into 3 categories: small malls, defined as having commercial space of less than 9,000 m2 ; intermediate size malls, defined as being larger than 9,000 m2 and smaller than 18,000 m2 ; and large malls, with a total commercial area of more than 18,000 m2 . For each category, the number of malls that adopt exclusivity clauses with hamburger chains and the number of hamburger restaurants in each (1, 2, or 3) is listed. As the table shows, 96% of small malls adopted exclusivity clauses with hamburger chains, while only 50% of the large malls adopted exclusive contracts with hamburger chains. Panel B of Table 3 presents the likelihood that an exclusivity clause was adopted in a mall alongside the level of competition a mall faces from other malls. I measure mall competition according to the number of malls within a radius of 5 kilometers,18 and define three levels of competition: weak competition, if there is no more than one other mall located within 5 kilometers; medium competition, if there are 2 or 3 competing malls within 5 kilometers; and strong competition, if there are more than 3 competing malls located within 5 kilometers. The descriptive statistics reveal a negative relationship between the number of 18 The 5-kilometer cutoff is based on the proposed guidelines published by the Israeli Antitrust Authority in its investigation of the effects of exclusivity clauses adopted by shopping malls. 14 malls located near a particular mall and the likelihood that this mall adopted an exclusivity clause with a hamburger chain. 4 Estimation and Results In this section, I test the hypotheses developed in Section 2. I first look at the determinants of exclusivity clauses (hypotheses 1-3) and subsequently examine their effects on the number of restaurants and on sales at the mall and at the restaurant level (hypotheses 4-6). 4.1 Estimation of the determinants of exclusive contracts To explore the determinants of exclusivity clauses, I estimated alternative versions of the following equation: EXCi = η + θ1 ∗ D1993,i + θ2 ∗ M all Compi + θ3 ∗ M all Sizei + τ1 ∗ N umber of Storesi + φ1 ∗ Xi + i (1) where EXCi , the dependent variable, is a dummy variable indicating whether a hamburger restaurant operates under an exclusivity clause in a given mall. Table 4 presents the results using alternative linear probability model specifications, with the entire sample of malls and malls with sales data analyzed separately and presented in the odd and even numbered columns, respectively. D1993 is an indicator variable for the mall’s opening year, taking the value of one if the mall opened before 1993 and zero otherwise. The coefficient on this variable is negative and statistically significant in all specifications. In columns 3 and 4 I use the M all Comp variable, which corresponds to the number of malls located within a 5-kilometer radius, and find that it also has a negative association with the use of exclusive contracts in a mall. Similarly, as shown in columns 5 and 6, I find a negative relationship between mall size and the adoption of exclusivity clause. In columns 7 and 8, I use these three variables to explain the decision to adopt exclusivity by the mall and the hamburger restaurant. The three variables are all negative and statistically significant (at p-value < 0.06) for the sample for which sales data 15 were available. In columns 9 and 10, similar qualitative results are derived when I add the following control variables: the total number of stores in the mall (number of stores); the income per capita of the residents in which the mall is located (per capita income); a dummy variable indicating whether the mall is a power center (i.e., an unenclosed shopping mall) and the number of hamburger restaurants located outside the mall and within a radius of 2 km (number of hamburger restaurants (2km)). The significance level of the mall competition variable falls to 0.12 in the sample for which sales data are available. The statistical significance further falls when the sample also includes malls in which McDonald’s is the exclusive chain in the mall. One interpretation of this result is that malls may be willing to grant exclusivity to McDonald’s, the market leader, regardless of the level of competition they face from other malls because the negative effect of having only a McDonald’s restaurant in the mall is not large. In contrast, malls are less likely to sign exclusive contracts with less dominant chains (Burger King or BurgeRanch) when the competition the mall faces from nearby malls is strong. Below, I turn to estimate the effects of exclusive contracts on the number of hamburger restaurants and on the hamburger restaurants’ sales. 4.2 Estimation of the effects of exclusive contracts Exclusive contracts between malls and hamburger chains might affect the number of hamburger restaurants in a mall, which, in turn, affects hamburger sales. However, estimating the causal relationship between exclusive contracts and the number of hamburger restaurants and between exclusive contracts and hamburger sales is challenging because the decision to establish exclusive contracts is likely to be correlated with unobserved demand conditions at the mall level. Without properly controlling for these unobserved factors, the estimated coefficients are potentially biased. This problem could be solved if we had an instrument for the decision to adopt an exclusive contract. Such an instrument must be important in explaining the decision to adopt exclusive contracts and hence the number of hamburger restaurants, but should have no direct effect on the number of restaurants and on sales by hamburger restaurants. I use the mall opening year, before versus after 1993, as an exogenous source of variation in 16 the tendency of malls and hamburger restaurants to adopt exclusive contracts. As explained above, following the entry of McDonald’s and Burger King to Israel in late 1993 and early 1994, BurgeRanch, the incumbent chain was no longer the only chain that could open hamburger restaurants in Israeli shopping malls. The use of a mall’s opening year, before or after 1993, as an instrumental variable is valid if it has no direct effect on the mall’s total hamburger sales, other than through its effect on the likelihood of incorporating an exclusivity clause in the lease agreement and therefore on the number of hamburger restaurants. After presenting the estimation results, I further discuss the validity of the instrument. 4.2.1 Number of hamburger restaurants I examine the relationship between exclusivity clauses and the number of hamburger restaurants in the mall by estimating the following 2sls regression: N umber of Resti = α1 + β1 ∗ EXCi + γ1 ∗ N umber of Storesi + δ1 ∗ Xi + i (2) where N umber of Resti is the number of hamburger restaurants in mall i and EXCi indicates whether an exclusivity clause between the mall and a hamburger chain is adopted in mall i. N umber of Storesi is the total number of mall stores, which serves as a proxy for the potential demand for hamburgers in the mall. In addition, Xi is a vector of the following covariates: per capita income, type of mall, mall size and the local competition variables; 1,i is a random error term. In this analysis, I use the mall opening date, before or after 1993, as an instrument for the adoption of an exclusive contract by the hamburger restaurant located in that mall. The regression results, reported in Table 5, support hypothesis 4 and indicate that the adoption of exclusivity contracts has a strong negative association with the number of hamburger restaurants in a mall. 17 4.2.2 Total sales by hamburger restaurants To explore the relationship between the adoption of exclusive contracts by hamburger chains located in malls and total mall-wide hamburger sales, I estimate the following: M all Hamburger Salesi = α1 + β1 ∗ EXCi + γ1 ∗ N umber of Storesi + δ1 ∗ Xi + i (3) where M all Hamburger Salesi represents the total annual sales of hamburger restaurants in a given mall, and EXCi indicates whether the mall and the hamburger restaurant adopted an exclusivity clause. The results are shown in Table 6. In column 1, the exclusivity clause is instrumented by the mall opening date, and measure its effect on mall total hamburger sales. In columns 2, instead of directly using the exclusive clause indicator, I use the fitted value of the number of hamburger restaurants obtained from equation 2 above. The estimates support hypothesis 5 and suggest that the adoption of exclusivity clauses has a negative effect on total hamburger sales through its effect on the number of hamburger restaurants in the mall. 4.2.3 Average sales by hamburger restaurants I now turn to examine the effect of exclusivity clauses on the average sales by a hamburger restaurant in a mall. I estimate the following specification: Sales per Resti = α1 + β1 ∗ EXCi + γ1 ∗ N umber of Storesi + δ1 ∗ Xi + i (4) where the dependent variable is the total hamburger sales in a given mall divided by the number of hamburger restaurants in that mall. As before, to control for the endogeneity of the exclusive contract I use the mall opening date as an instrument. The results are presented in column 3 in Table 6. The coefficients for the exclusive clause, total number of stores and per capita income variables are positive. However, the coefficient for the exclusive clause is not statistically significant. Thus, based on these results we cannot support or refute efficiencybased models of exclusive contracts (hypothesis 6). 18 4.3 Robustness and the validity of the instrument The validity of the findings presented above depends on whether the mall opening date is a valid instrument – that is, whether the mall opening date affects hamburger sales at the malls only through its effect on the tendency to adopt exclusive contracts and hence on the number of hamburger restaurants. The opening date instrument may not be a valid instrument if malls that opened before 1993 were able to secure better locations, thereby attracting more shoppers compared with malls that opened after 1993. If this is the case, then the larger number of hamburger restaurants and higher total mall hamburger sales in these “older” malls may be erroneously attributed to the lack of an exclusivity contract rather than to the better locations of these malls. In other words, the concern is that the sales of hamburger restaurants in 2002 are directly affected by the ”ages” of the respective malls rather than by the adoption of exclusivity contracts. Three types of evidence indicate that this is not likely to be the case. First, in Appendix B I use data on mall apparel sales to examine whether malls that opened before 1993 had higher sales compared with malls that opened after 1993. If older malls are indeed better located, then one would expect apparel sales in these malls to be higher than those in newer malls. The empirical evidence from this analysis implies that apparel sales in malls that opened before 1993 are, if anything, lower than apparel sales in newer malls. Second, I also use the age of a mall, defined as (2002 - the year the mall opened), to test whether age has a direct effect on hamburger sales. If older malls have an early-mover advantage in securing better locations then these malls should have higher total hamburger sales, and this should be reflected in the regression analysis. Yet, various specifications illustrate that the age of the mall has a statistically insignificant relationship with total hamburger sales. Third, various industry measures rank the profitability of Israeli malls, typically according to average sales and rent payments in each mall. These annual rankings indicate that older malls are generally less attractive than newer malls. To further test the robustness of my results, I also experimented with additional specifications. For instance, I obtain similar results when I use probit regressions to investigate the determinants of exclusivity. In addition, in the sales regressions I obtain similar qualitative 19 results if I instrument for the number of hamburger restaurants using the mall opening date. Furthermore, the results are qualitatively similar when I estimate a system of equations (3sls) in which exclusive clauses, the number of restaurants and total hamburger sales are used as interrelated dependent variables. The results also do not hinge on including particular large or small malls, or on changes in the way competition from other hamburger restaurants is defined. Controlling for the ownership of multiple malls also does not affect the results. In addition, I examined the sensitivity of the results to the assumption that a McDonald’s restaurant sells as much as the other hamburger restaurants in the same mall. I find that my results concerning the effect of exclusivity clauses on sales (through their effect on the number of hamburger restaurants) are unchanged as long as the annual sales of a McDonald’s restaurant are above 70% of the sales of another hamburger restaurant in the same mall. 5 Discussion The empirical analysis above provides different types of evidence concerning the determinants and effects of exclusive contracts between mall owners and hamburger restaurants. The evidence generally supports theoretical models that emphasize the anti-competitive role of exclusive contracts. Furthermore, efficiency-based models of exclusive contracts do not seem to fit well with the particular setting studied in this paper. Such theoretical models often focus on settings in which advertising or other pre-sale services are carried out by retailers. A common argument in these models is that when retailers face competition these “public goods” services, e.g., advertising, will be undersupplied because retailers are concerned that competing retailers will free-ride on their investments. These models stress that exclusive contracts can solve these incentive problems because retailers that operate under exclusive contracts are assured that competing retailers will not free-ride on their investments. In contrast to the setting in these models, advertising in the fast-food industry is carried out almost exclusively at the national, rather than the retailer, level. Thus, concerns that the extent of advertising is affected by whether a particular restaurant operates under exclusive contracts are likely unwarranted. 20 Also, because fast-food restaurant chains invest substantial resources in enhancing uniformity and standardization across their restaurants (Ater and Rigbi (Forthcoming)) it is difficult to see how an exclusive contract between a shopping mall and a chain-affiliated fast-food restaurant would significantly change the conduct of that restaurant compared to other restaurants from the same chain that do not operate under an exclusive contract. Still, concluding that these exclusive contracts necessarily lead to lower consumer surplus might be premature for several reasons. First, when the space allocated to hamburger chains in a mall is limited, the space available for other retailers (e.g., ice cream vendors) increases. Hence, one may need to compare the effects of the reduced variety in the hamburger chain market to those of the increased variety in the ice cream market.19 Second, the magnitude of the adverse effect of exclusive contracts on consumers also depends on the availability of other quick meal options in the mall. To the extent that there are such alternatives, the effect on consumers may be limited. Third, the empirical analysis in this paper may not capture some of the benefits associated with exclusive contracts. For instance, exclusive contracts may allow mall owners to attract anchor tenants at the early stages of establishing a mall or to induce other specific investments. To the extent that these efficiencies exist and do not affect the sales by hamburger restaurants, the negative effect of the exclusive arrangements might be overstated. 6 Concluding remarks Both the motivations behind and the implications of exclusive contracts have drawn considerable attention from economists, legal scholars, and practitioners. Yet, despite the extensive body of theoretical literature and the contentious policy debate over exclusive contracts, there 19 Arguably, the overall effect of exclusive contracts between hamburger restaurants and shopping malls on consumer surplus should be negative because the adoption of exclusive contracts distorts the optimal mix of stores in the mall. In other words, if having one hamburger restaurant and one ice cream vendor rather than two hamburger restaurants makes the mall more attractive for consumers (and hence leads to higher consumer spending), then mall owners should prefer to lease space to an ice cream vendor rather than to a second hamburger restaurant (regardless of the use of exclusive contracts). However, if, as the evidence suggests, the use of exclusive contracts affects the chosen mix of stores in the mall then it seems likely that mall owners adopt exclusive contracts to extract revenues from the incumbent restaurant at the expense of consumer surplus. The theoretical model in appendix A formalizes this point. 21 is almost no empirical evidence relating to these contracts. In this paper, I have attempted to address this gap in the literature. Using a unique data set comprising characteristics of malls in Israel, hamburger restaurant sales, and data on the adoption of exclusivity clauses, I examined both the sources and implications of these exclusive arrangements. I found that exclusivity clauses are less likely to be adopted in large malls and in malls that face more competition from nearby malls. I also find that exclusive contracts are less likely to have been adopted by malls that were open to the public since before the entry of McDonald’s and Burger King into the Israeli market. Following the entry of these chains, the local hamburger chain market became an oligopoly, and hamburger chains began incorporating exclusivity clauses into their contracts. I take advantage of this unforeseen change in the market structure, to estimate an instrumental variable regression that examines the effect of exclusive contracts on the number of hamburger restaurants and on hamburger sales. I find a strong negative relationship between exclusive contracts and the number of hamburger restaurants and also a negative effect of exclusive contracts on total hamburger sales. Overall, my findings regarding the private incentives to adopt exclusive contracts and their effects are generally consistent with vertical foreclosure models. Taken together, the findings of this paper provide novel evidence that exclusivity clauses may have anti-competitive effects. The implications of my results are potentially relevant to other settings in which a dominant firm denies access to the essential good it produces. For example, my analysis might be relevant for media and internet platforms that sign exclusive arrangements with advertisers. Though the specific effects might vary, the analysis in this paper could guide the analysis in these cases as well. References Aghion, P. and Bolton, P.: 1987, Contract as a barrier to entry, American Economic Review 77(3), 388–401. Asker, J.: 2005, Diagnosing foreclosure due to exclusive dealing, http://www.johnasker.com/ 22 OWPs.html. Ater, I. and Rigbi, O.: Forthcoming, Price control and advertising in franchising chains, Strategic Management Journal . Bar-Isaac, H. and Gavvazza, A.: 2013, Brokers contractual arrangements in the manhattan residential rental market, https://sites.google.com/site/heskibarisaac/home/ abstracts. Bernheim, B. D. and Whinston, M. D.: 1998, Exclusive dealing, Journal of Political Economy 106, 64–103. Chipty, T.: 2001, Vertical integration, market foreclosure, and consumer welfare in the cable television industry, American Economic Review 91, 428–453. Clarkson, K. W. and Muris, T. J.: 1981, Federal Trade Commission since 1970: Economic Regulation and Bureaucratic Behavior; Exclusionary Practices: Shopping Center Restrictive Covenants, Cambridge University Press. Cooper, J. C., Froeb, L. M., O’Brien, D. and Vita, M. G.: 2005, Vertical antitrust policy as a problem of inference, International Journal of Industrial Organization 23, 639–664. Fershtman, C. and Gandal, N.: 1998, The effect of the arab boycott on israel: The automobile market, RAND Journal of Economics 29, 193–214. Hart, O. and Tirole, J.: 1990, Vertical integration and market foreclosure, Brookings Papers on Economic Activity: Microeconomics 205-276 . Kalnins, A.: 2004, An empirical analysis of territorial encroachment within franchised and company-owned branded chains, Marketing Science 23(4), 476–489. Krattenmaker, T. G. and Salop, S.: 1986, Anticompetitive exclusion: Raising rivals’ costs to achieve power over price, Yale Law Journal 96, 209–293. Kuhn, K. and Vives, X.: 1999, Excess entry, vertical integration and welfare, Rand Journal of Economics 30, 575–603. 23 Lafontaine, F. and Slade, M.: 2008, Handbook of Antitrust Economics, Exclusive Contracts and Vertical Restraints: Empirical Evidence and Public Policy, MIT Press, pp. 391–414. Martin, S., Normann, H.-T. and Snyder, C. M.: 2001, Vertical foreclosure in experimental markets, RAND Journal of Economics 32, 466–496. Marvel, H. P.: 1982, Exclusive dealing, Journal of Law and Economics 25, 1–25. Marx, L. and Shaffer, G.: 2007, Upfront payments and exclusion in downstream markets, Rand Journal of Economics 38, 823–843. Miklos-Thal, J., Rey, P. and Verge, T.: 2011, Buyer power and intrabrand competition, Journal of the European Economics Association 9, 721–741. Nurski, L. and Verboven, F.: 2013, Exclusive dealing as a barrier to entry? evidence from automobiles, http://www.econ.kuleuven.be/public/ndbad83/Frank/Papers.htm. Rasmusen, E. B., Ramseyer, J. M. and Wiley, J. S.: 1991, Naked exclusion, American Economic Review 81, 1137–1145. Rey, P. and Tirole, J.: 2007, Handbook of Industrial Organization, A Primer on Foreclosure, Vol. 3, North-Holland, Amsterdam. Sass, T.: 2005, The competitive effects of exclusive dealing: Evidence from the u.s. beer industry, International Journal of Industrial Organization 23, 203–225. Suzuki, A.: 2009, Market foreclosure and vertical merger: A case study of the vertical merger between turner broadcasting and time warner, International Journal of Industrial Organization 27, 532–543. Telser, L.: 1960, Why should manufacturers want fair trade?, Journal of Law and Economics 3, 86–103. Whinston, M.: 2006, Lectures on Antitrust Economics, MIT Press. 24 Burger King - 2002 Sales, Rent & Sales promotion (1000*shekels) Sales Sales All restaurants Mall restaurants # of restaurants 56 23 Mean 2360 3091 Std. 1081 1140 Min 692 813 Max 5568 5568 Rent Rent All restaurants Mall restaurants 56 23 254 292 146 176 51 111 707 707 Sales Promotion Sales Promotion All restaurants Mall restaurants 56 23 2 2 3 1 0 0 25 5 Min 718 1173 Max 6037 4396 BurgeRanch - 2002 Sales (1000*shekels ) Sales Sales All restaurants Mall restaurants # of restaurants 71 29 Mean 2266 2590 Std. 1065 937 Table 1: Descriptive statistics for Burger King and BurgeRanch restaurants in 2002 Throughout the paper, the figures are in thousand Israeli Shekels (1 dollar ≈ 4 shekels). 25 Panel A: malls where McDonald's operates under an exclusive clause (N=24) Mean Std. Dev. Mall competition (5km) 2.92 2.87 Number of stores in the mall 69.46 60.74 Mall size (1000*m2) 13.05 9.66 Number of hamburger restaurants (2 km) 0.46 1.06 Power center 0.17 0.38 Per capita income (*1000 shekels) 3.36 0.83 Mean number of hamburger restaurants in a mall 1.17 0.48 Panel B: malls where Burger King operates under an exclusive clause (N=15) Mean Std. Dev. 2.67 1.63 Mall competition (5km) 78.53 58.54 Number of stores in the mall Mall size (1000*m2) 13.93 9.13 0.67 1.05 Number of hamburger restaurants (2 km) 0.20 0.41 Power center 3.41 0.77 Per capita income (*1000 shekels) 1.07 0.26 Mean number of hamburger restaurants in a mall Panel C: malls where BurgeRanch operates under an exclusive clause (N=14) Mean Std. Dev. 1.71 2.43 Mall competition (5km) 53.64 29.08 Number of stores in the mall Mall size (1000*m2) 9.11 4.05 0.57 0.76 Number of hamburger restaurants (2 km) 0 0 Power center 3.08 0.81 Per capita income (*1000 shekels) 1 0 Mean number of hamburger restaurants in a mall Panel D: malls in which no exclusive clause was adopted (N=15) Mean Std. Dev. 3.80 2.54 Mall competition (5km) 120.53 49.37 Number of stores in the mall Mall size (1000*m2) 22.10 10.12 0.73 1.44 Number of hamburger restaurants (2 km) 0.13 0.35 Power center 3.50 0.73 Per capita income (*1000 shekels) Mean number of hamburger restaurants in a mall 2.13 0.51 Table 2: Summary statistics for malls, by chain and adoption of exclusive clauses The different panels show summary statistics for the malls in which the different hamburger chains adopt exclusive contracts with malls. Mall competition refers to the number of malls located within 5 kilometers from a given mall. The number of hamburger restaurants variable counts the number of hamburger restaurants located outside a given mall and within a radius of 2 kilometers from the mall. Other variables are explained in the text. 26 Panel A - adoption of exclusive clauses and mall size Mall size Small Intermediate Large Number of malls 25 25 18 Number of malls that adopt exclusive clauses 24 20 9 Number of malls with one hamburger restaurant 25 20 5 Number of malls with two hamburger restaurants 0 5 9 Number of malls with three hamburger restaurants 0 0 4 Panel B - adoption of exclusive clauses and mall competition Mall competition (number of nearby malls) 0-1 2-3 3+ Number of malls 25 19 24 0.92 0.73 0.66 Fraction of malls that adopt exclusive clauses Table 3: Summary statistics on adoption of exclusive clauses, mall size and mall competition Panel A presents descriptive statistics for the relationship between the adoption of exclusivity clauses and mall size. Small malls are defined as having commercial space of less than 9,000 m2 ; intermediate size malls, defined as being larger than 9,000 m2 and smaller than 18,000 m2 ; and large malls, with commercial area of more than 18,000 m2 . Panel B displays evidence of the the relationship between adoption of exclusive clauses and mall competition. Mall competition is measured by the number of competing malls located within a radius of 5 kilometers of a given mall. 27 (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) The dependent variables indicates whether an exclusive clause is adopted by the hamburger chain and the mall All Malls All Malls All Malls All Malls All malls with malls with malls with malls with malls sales sales sales sales Malls with sales Variables D1993 -0.32*** -0.28* -0.27** -0.32** -0.29** (0.12) (0.15) (0.11) (0.13) (0.11) (0.13) -0.02 -0.05* -0.01 -0.07* Mall competition -0.04* -0.07** (0.02) (0.03) Mall size (in m2) (0.02) (0.03) (0.03) (0.04) -0.02*** -0.03*** -0.02*** -0.02*** -0.03** -0.04* (0.01) (0.01) (0.01) (0.01) (0.01) (0.02) Number of stores Per capita income # of hamburger restaurants (2km) Power center Constant Observations R-squared -0.32** 0.01 0.01 (0.01) (0.01) -0.06 -0.05 (0.06) (0.08) 0.01 0.09 (0.05) (0.07) 0.18 0.15 (0.22) (0.28) 0.85*** 0.74*** 0.87*** 0.84*** 1.04*** 1.05*** 1.14*** 1.25*** 1.34*** 1.44*** (0.05) (0.08) (0.08) (0.11) (0.08) (0.12) (0.09) (0.12) (0.22) (0.29) 68 44 68 44 68 44 68 44 68 44 0.10 0.07 0.04 0.10 0.18 0.27 0.27 0.41 0.31 0.48 *** p<0.01, ** p<0.05, * p<0.1 Standard errors in parentheses Table 4: Determinants of exclusivity clauses The dependent variable is a dummy variable indicating whether the lease agreement of the hamburger chain that operates in the mall includes an exclusivity clause. D1993 is an indicator variable which equals one if the mall was open before 1993. The mall competition variable corresponds to the number of malls located within a radius of 5 kilometers from a given mall and mall size refers to a mall leasable area in m2 . Other variables are explained in the text. In odd numbered columns, the sample includes all the malls, including malls where McDonald’s is the only chain that operates in the mall. In even numbered columns, the sample includes malls where BurgeRanch, Burger King or both chains operate a restaurant in the mall, i.e. malls for which sales data are available. 28 (1) (2) Dependent variable is the number of mall hamburger restaurants 2sls All malls Variables EXC -0.62*** (0.24) Mall competition 0.01 (0.02) Mall size (in m2) 0.02** (0.01) Number of stores 0.02** (0.01) Per capita income 0.04 (0.04) # of hamburger restaurants (2km) -0.01 (0.02) Power center -0.12 (0.14) Constant 1.12*** (0.32) Observations 68 R-squared 0.84 *** p<0.01, ** p<0.05, * p<0.1 Standard errors in parentheses 2sls Malls with sales -0.69** (0.21) 0.01 (0.02) 0.03*** (0.01) 0.001 (0.01) 0.06 (0.04) -0.01 (0.02) -0.29* (0.15) 1.16*** (0.32) 44 0.89 Table 5: Regression results for the number of mall hamburger restaurants The table shows the results for 2sls regressions in which the dependent variable is the number of hamburger restaurants in the mall. The sample of malls in column 1 include all the malls where at least one hamburger restaurant operates. The sample in column 2 contains only shopping malls for which sales data are available. EXC is a dummy variable indicating whether an exclusivity clause is adopted between the mall and the hamburger chain. I use the mall opening date, before or after 1993, as an instrument for the decision to adopt the exclusivity clause. Other variables are explained in the text. 29 Dependent variable: Variables EXC (1) (2) total hamburger sales 2sls ols (3) sales per restaurant 2sls -2,625* (1,349) 257.6 (776.1) -31.12 (164.81) Mall size (in m2) -8.35 (66.60) Number of stores 30.58*** (9.61) Per capita income 417.0 (285.8) # of hamburger restaurants (2km) 71.39 (145.9) Power center 279.6 (945.5) Constant 1,858 (2,066) Observations 44 R-squared 0.77 *** p<0.01, ** p<0.05, * p<0.1 2,218*** (807.0) 43.46 44.26 (140.4) (94.76) -46.34 -34.43 (85.28) (38.30) 28.71** 15.61*** (12.21) (5.524) 348.1 342.0** (284.9) (164.3) 29.14 -21.30 (143.0) (83.89) 752.7 590.1 (972.7) (543.8) -2,194** 557.8 (1,076) (1,188) 44 44 0.79 0.39 Standard errors in parentheses Number of hamburger restaurants Mall competition Table 6: Regression results for the effect of exclusive contracts on hamburger sales Columns 1 and 2 present regression results in which the dependent variable is the total annual sales of the hamburger restaurants in a mall. In columns 1, the exclusive clause variable is instrumented by a dummy variable indicating whether the mall was opened before or after 1993, the year in which McDonald’s and Burger King entered the Israeli market. In column 2, instead of the exclusive clause variable, I use the fitted value of the number of hamburger restaurants in the mall, obtained from equation 2 (Table 5). Column 3 shows the 2sls regression results using the average hamburger restaurant sales as the dependent variable. Like in column 1, I use the D1993 indicator, which equals one if the mall was opened before 1993, to instrument for the decision to adopt an exclusive clause. Other variables are explained in the text. 30 Figure 1: Total mall hamburger sales as a function of the total number of stores Total sales by mall hamburger restaurants are plotted against the total number of mall stores. Malls that do not adopt exclusive contracts with a hamburger chain are denoted by hollow circles and the size of the circle corresponds to the number of hamburger restaurants in a given mall. Malls that were open before McDonald’s and Burger King entered the Israeli market are denoted by a small x. 31 A Appendix A - a theoretical model The theoretical model can be used to guide the empirical analysis presented in the paper. The model establishes the following predictions: First, larger malls are less likely to adopt exclusivity clauses with hamburger restaurants. Second, there exists a negative relationship between the adoption of exclusivity clauses and the number of hamburger restaurants in the mall. Third, exclusive clauses have a negative effect on total mall hamburger sales. Let π(n, s) denote the per restaurant gross profits (not including the rent payments to the mall) when a total of n hamburger restaurants operate at a mall with s stores. Here, s can be thought of as a proxy for the demand for hamburgers in the mall. It is assumed that πn‘ is weakly decreasing (e.g. due to business stealing) and that πs‘ is weakly increasing in s. “ is weakly negative, implying that the business-stealing effect becomes weaker In addition, πn,s as the total number of stores in the mall increases. Restaurants pay a share α of their gross profits to the mall owner, where α ∈ (0, 1). An additional payment, ED(n, s), is made if the mall owner commits to not allowing a second restaurant to enter the mall. Signing an exclusivity clause must be beneficial for both the restaurant and the mall owner. The incumbent restaurant will pay to prevent entry if, without an exclusive contract, entry will take place and reduce the incumbent’s profits. The ED payment is determined as a function of the losses that the incumbent restaurant will incur if entry occurs. Hence, ED = κ[π(1, s)−π(2, s)] where κ ∈ (0, 1).20 Finally, a is the rent the mall would earn from the best available non-hamburger outlet alternative. It is assumed that more attractive retailers enter the mall before less attractive retailers. Hence, there is an inverse relationship between a and s, the number of stores already in the mall. I focus on a situation in which n ∈ {0,1,2}; thus, adoption of exclusivity clauses is an issue at the margin between 1 and 2 restaurants. I consider first a situation in which exclusivity clauses are possible and compare it to the situation when exclusivity clauses are not possible. The following market structure is derived when exclusivity clauses are possible: 20 A simplifying assumption that I use in the model is that the rival restaurant does not participate in the contracting stage. This can occur, for instance, if the mall owner incurs transaction costs if she simultaneously deals with multiple chains. Bernheim and Whinston (1998) offer a full-fledged model that shows how relaxing this assumption does not affect the results. 32 α ∗ π(1, s) < a(s) ⇒ n∗ = 0 α(2π(2, s) − π(1, s)) < a(s) < α ∗ π(1, s) ⇒ n∗ = 1 (1) α(2π(2, s) − π(1, s)) − ED(n, s) < a(s) < α(2π(2, s) − π(1, s)) ⇒ n∗ = 1 α(2π(2, s) − π(1, s)) − ED(n, s) > a(s) ⇒ n∗ = 2 The structure implies that the larger the number of stores, the larger the number of hamburger restaurants that operate in the mall. If exclusivity clauses are not allowed, then the market structure is changed in cases in which ED payments were previously used to prevent entry. In particular, the following structure is obtained: α ∗ π(1, s) < a(s) ⇒ n∗∗ = 0 α(2π(2, s) − π(1, s)) < a(s) < α ∗ π(1, s) ⇒ n∗∗ = 1 (2) a(s) < α(2π(2, s) − π(1, s)) ⇒ n∗∗ = 2 A comparison of the industry structure under the two regimes is plotted in Figure 2a for different values of s. s∗1 , the minimum number of mall stores required to sustain one restaurant, is given implicitly by α ∗ π(1, s∗1 ) = a(s∗1 ); s∗ED , the minimum number of mall stores for which the mall owner signs an effective exclusive contract, is given implicitly by α(2π(2, s∗ED ) − π(1, s∗ED )) = a(s∗ED ). In addition, s∗2 ,the minimum number of mall stores for which the mall owner would lease space to two hamburger restaurants, is given implicitly by α(2π(2, s∗2 ) − π(1, s∗2 )) − ED(n, s∗2 ) = a(s∗2 ). It can be shown that s∗1 < s∗ED < s∗2 . Note that when exclusive clauses are possible, there are two cases in which one restaurant operates in the mall. For malls with relatively few stores, between s∗1 and s∗ED , the mall owner’s alternative is more attractive than the additional rent from a second hamburger restaurant. Therefore, within this range, an exclusivity clause (if it exists) is superfluous. For malls with an intermediate number of stores, s∗ED < s < s∗2 , the threat of entry becomes likely because the mall’s rent from a non-hamburger restaurant becomes lower and the additional rent from a second restaurant is larger than it is in small malls. It is in this range where exclusivity clauses directly affect the number of hamburger restaurants and total sales of hamburger 33 restaurants. Finally, for malls with a relatively large number of stores, s > s∗2 , the rent from a non-hamburger restaurant is low, and due to the high differentiation across retailers, the willingness of the incumbent hamburger restaurant to pay for an exclusive contract drops. As a result, in large malls exclusivity agreements will not be signed, and a second restaurant will enter the mall. Letting q(n,s) represent per-firm hamburger restaurant sales and Q(n, s) = nq(n, s) represent total hamburger sales in the mall, it is straightforward to show that the total quantity sold by hamburger restaurants is lower when exclusive contract is adopted. This is illustrated graphically in Figure 2b. 34 Figure 1: Graphic illustration of the main results of the model The blue dotted line corresponds to the equilibrium when exclusive contracts are possible. The black solid line shows the predicted changes in the number of hamburger restaurants in the mall and in the total quantity sold by hamburger restaurants if exclusive contracts are prohibited. As the figure shows, removing exclusive contracts leads to entry of an additional hamburger restaurant in malls with intermediate size. Furthermore, total hamburger sales are lower in malls in which the exclusive contracts are effective in preventing entry. 35 B Appendix B - apparel sales data In the main text, I use the opening date of a shopping mall – before or after 1993 – as an instrumental variable that helps identify the effect of exclusive contracts on total sales by hamburger restaurants in a given mall. The validity of the instrumental variable is threatened if malls that opened before 1993, the year in which McDonald’s and Burger King entered the Israeli market, secured better locations, and hence attract more shoppers. In this appendix I show regression results that demonstrate that malls that opened before 1993 are not more attractive than malls opened after 1993. Such evidence supports the validity of using the mall opening date as an instrumental variable when estimating the effect of exclusivity clauses on sales by hamburger restaurants. The apparel data come from an Israeli retail consultancy firm that obtains monthly data on several retail chains that operate in shopping malls across Israel. The monthly data span from January 2006 to August 2010. I aggregate the data to obtain an average measure for each mall and focus on malls that are included in my 2002 sample. In particular, I estimate the following equation: Apparel Salesi = α1 + β1 ∗ D1993,i + γ1 ∗ N umber of Storesi + δ1 ∗ Xi + i (3) The dependent variable is the mall average apparel sales per square meter which serves as a measure for the attractiveness of the mall. I use this measure rather than total mall apparel sales because not all apparel stores report their sales to the consultancy firm and hence a measure of total apparel sales is not available. Other regressors are similar to the regressors in equation 2 in the main text, except that I replace the EXC variable with a dummy variable D1993 . The coefficient of interest is β. The results are reported in Table B1 and indicate that malls that were opened before 1993 do not have higher apparel sales per square meter; thus, these results mitigate the concern that the instrumental variable regression results presented in the main text are driven by the better locations of malls that opened before 1993. 36 (1) (2) Dependent variable is apparel sales per sqm. all malls malls with sales Variables D1993 -178 -324 (178) (187) -0.52 50.4 (46.3) (55.3) -29.0 -30.3 (19.5) (24.8) 10.2*** 10.7** (3.36) (4.31) 175* 285** (98.3) (121) 69.5 -3.28 (45.2) (56.0) 137 -30.2 (360) (423) 730** 523 (333) (402) 57 37 0.47 0.57 Standard errors in parentheses Mall competition Mall size (in m2) Number of stores Per capita income # of hamburger restaurants (2km) Power center Constant Observations R-squared *** p<0.01, ** p<0.05, * p<0.1 Table B1: Apparel sales regressions The dependent variable is apparel sales per square meter in each mall. Other regressors are similar to the regressors in equation 2 in the main text, except that I replace the EXC variable with a dummy variable that equals one if the mall was opened before 1993 and zero otherwise. The sample in column 2 includes only malls for which I also have data on hamburger sales. 37
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