Upfront Payment, Renegotiation and (Mis)coordination in Multilateral - - PowerPoint PPT Presentation

Upfront Payment, Renegotiation and (Mis)coordination in Multilateral Vertical Contracting

by IGOR Mouraviev

Upfront Payment

Key features

Paid at signature of contract Not related to volume of purchases (lump‐sum) Term: slotting allowances

Examples

Grocery stores Drug stores Book stores, record stores

Manufacturer Retailer

Payment before any purchase Payment per unit of purchase

Upfront Payment

To get access to retailers’ (limited) shelf space ‐ just placement on shelves ‐ premium placements (eye‐level shelves, special displays) To have new products introduced in their stores To stay in retailer’s list of potential suppliers

Why do manufacturers (unwillingly) pay slotting fees?

Upfront Payment

If retailers are capable to demand slotting fees, why don’t they ask for lower wholesale prices instead? Why do manufacturers agree (perhaps unwillingly) to pay slotting fees? What is the impact of slotting fees on prices, and how do they affect market structure?

Main issues to address

Literature

R1 R 2 MA

Intra‐brand competition only Miklos‐Thal et al. 2010, Bedre 2009:

• 2. Monopoly prices are sustained
• 1. There always exist CA equilibrium

MA MB R1

Inter‐brand competition only Marx and Shaffer 2008: Caprice and Schlippenbach 2010 (consumer shopping costs):

• 3. Exclusion of less efficient R is always equilibrium
• 4. Prices are still at monopoly levels
• 1. There always exist CA‐SPNE
• 2. No marginal cost pricing

Aim of paper

Question Do we obtain the same results in a situation where oligopolistic competition exists both upstream and downstream?

Set up

MA MB R1 R 2

One link is missing; technical but

R2 delist MA and launch its

• wn‐label imitation

entry of R2 was initiated by MB

provided exclusivity

negotiations between MA and R2

ended in break‐down

Toy R Us Inc. v. FTC (1996)

Remark

No asymmetry of information No shopping costs intra‐brand competition inter‐brand competition inter‐brand competition between

retailers

Key features

Main Findings

1.

In all equilibria firms fail to sustain industry‐wide monopoly profit

2.

Use of slotting fees in equilibrium ‐ MB may use them to dampen intra‐brand competition ‐ MA may use them to compensate for negative impact of sales of its product on total profits from selling product B

3.

There do not always exist equilibria in which retailers carry products of all their respective suppliers

Modeling Assumptions

A1 Each pair Mk‐Ri negotiates three‐part tariffs contract T (q ) =

ki ki

w q + F + S S

ki ki ki ki ki

for q > 0

ki

for q = 0

ki

where is unconditional fee (slotting fee, if negative) unrelated to volume of purchases by Ri

S ki

is price per unit of good purchased by Ri

wki

is conditional fee related to volume of purchases by Ri

Fki

Modeling Assumptions

A2 Both manufacturers and retailers have differentiated and

balanced bargaining power

A3 Negotiation in each pair Mk‐Ri is alternating‐offer bargaining

game á la Binmore et al. (1986)

Max (u (C ) – d

)

C

ki M k |Mk M k|R i ki 1 – λki(u (C ) – d

)

Ri Ri ki λ ki

C ≡ (w ,F ,S )

ki ki ki ki

where and are disagreement payoffs

d M k|R i

|Mk

dRi

Modeling Assumptions

all contracts signed earlier are renegotiated from scratch

Motivation

Firms can renegotiate contracts at any time before retail competition Renegotiation in case of material change of circumstances

A4 Disagreement payoffs are obtained using approach of

Stole and Zwiebel (1996)

if Mk and Ri fail negotiations, they cannot renegotiate

at another time Implication and do not depend on C

d M k|R i

|Mk

dRi

ki

Order of Negotiations

Stage 1 MA and R1 negotiate Stage 2 MB and R1 negotiate Stage 3 MB and R2 negotiate If all negotiations succeeded, then Stage 4 If negotiations in some Mk‐Ri fail, then

MA MB R1 R 2

Each Ri decides on quantities to purchase from Mk Retail competition takes place All payoffs are realized Mk and Ri will never renegotiate

4’

Negotiations start from beginning preserving same order

Stage

First Result

In any SPNE in which all links are active, firms fail to implement monopoly outcome.

Main Result Fully monopoly outcome can be sustained

Contrast with literature

Intra‐brand competition only

MB R1 R 2 MA MB R1

Inter‐brand competition only

First Result: Intuition

π (w) = R (q (w),q (w)) – w q (w)

Ri

Bi B1 B2 Bi Bi

M B

π (w) = (w – c )q (w) + (w – c )q (w)

B1 B B2 B1 B2 B

Variable profits MA is inactive

MB R1 R 2

Main Results (Bedre, 2009)

Wholesale prices are set at levels generating monopoly profits MB pays slotting fee to R1 only B2 B1

(w ,w ) = argmax П (w) ≡ π (w) + π (w) + π (w)

B1B2

M B R1 R2

w

m m

w ≡ (w ,w )

B2 B1 B2 B1 B1B2

S = – λ П +

B1

m

λ (1 – λ )

B2 B1

(1 – λ )

B2

П – П

B1

m m

First Result: Intuition

Intuition

Start with w

, w > c

B2 B1 B

m m

Suppose that MB and R1 set wB1

m

MB and R2 always wish to free‐ride on wB1

m MA is inactive

MB R1 R 2

B2

*

B2

w = argmax П (w , w ) ≡ π (w , w ) + π (w , w )

B1 MB R 2

m

wB2

B2 B1

m

B2 B1

m

B2

= argmax П (w , w ) – π (w , w ) < w

B1B2 B2

m

B1 B2 R1 B1

m

B2

wB2

m

B1

wm

*

B2

w

First Result: Intuition

Intuition

R1 protects itself against opportunistic

move of MB; gives up all its variable profit

F = R (q (w ), q (w )) – w q (w )

B1 B1 B1 B2 B1 B1

m m m m

R1 gets its share of gains from trade with MB through slotting fee! If R2 and MB decrease w

then they loose F and get

B1 B2

MA is inactive

MB R1 R 2

B1

wm

*

B2

wB2 wm

Set wholesale prices at levels w

, w

B2 B1

m m

B1B2

П m П <

B2

m

B2

П =

d

First Result: Intuition

MA is active

MA MB R1 R 2

Clear: Slotting fees and renegotiation imply that in any SPNE MB, R1 and R2 maximize their joint trilateral profits:

B2 B1

(w ,w ) = argmax ПB1B2 (w ,w )

B2 B1

(w , w , w )

B2 B1 A1

̃

* *

but because of MA they do it subject that MB and R2 cannot gain from decreasing w :

B2

ПB1B2 ≥ ПB2

d

(w , w , w )

B2 B1 A1

̃

– π R1

A1(w

, ∞ , w )

B2 A1

*

B2

w

*

B1

w

First Result: Intuition

• r

R1 removes only B

MA MB R1 R 2

R1 removes both A and B

MA MB R1 R 2

Depending on (w , F ), joint bilateral profit from deviation is

A1 A1

(since A and B are imperfect substitutes)

ПB2

d

П ,

B2 ПB2 m

By decreasing w , MB and R2 can induce two continuation equilibria:

B2

[ [

Є (since B1 and B2 are imperfect substitutes)

̃

Assumption A5 for all

∂ПB1B2 ∂w ∂wB2

B1

< 0

A1

w

First Result: Intuition

Lemma Suppose that A5 holds, then the solution to problem MA is active (continued)

* *

B2 B1

(w (w ,П ), w (w ,П )) = argmax ПB1B2 (w ,w )

B2 B1

(w , w , w )

B2 B1 A1

̃

A1 B2 A1 B2 d d

s.t. ПB1B2

≥ ПB2

d

(w , w , w )

B2 B1 A1

̃

– π R1

A1(w

, ∞ , w )

B2 A1

implies

w (w ,П ) ≤ w (w )

B2

*

A1 B2 d A1 B2

̃

B1

w (w ) ≤ w (w ,П ) and

*

A1 B2 d B1

̃

A1

Property

B1 B1

w (w ) < w

̃

A1

m m

B2 B2

w (w ) < w

̃

A1

m m and Intuition MB, R1 and R2 have incentives to free‐ride on MA’s margin

Second Result

If intensity of inter‐brand rivalry between retailers is sufficently strong, then MA may need to pay R1 a slotting fee. MA MB R1 R 2

MB pays upfront to suppress intra‐brand competition between R1 and R2 MA pays upfront to compensate for negative impact of A

• n total sales of B

Slotting fees are irrelevant

Remark

MA MB R1

Second Result: Intuition

subject to following constraints

• 1. MB, R1 and R2 cannot jointly gain from excluding MA

Negotiations between MA and R1 imply

max П w ,FA1

A1

(w , w , w )

B2 B1 A1

MA MB R1 R 2

1 B1B2

F ≤ П (R carries A) – П (R removes A)

B1B2

̃

A1 1

Implication F should be lower

A1

• 2. Impact of (w , F ) on w

and w in continuation equilibrium

A1 A1 B1 B2

(w , F )

A1 A1

П B2

d

w

and w

B1

*

B2

*

П (w , w , w )

B2 B1 A1

Second Result: Intuition

(from point of view of maximizing total profits) Gain for MA

reduce competitive pressure on its product

Gain for R1

reduce incentives of MB to free‐ride on its contract with R1

MA MB R1 R 2

Key points w and w are strategic complements

A1 B1

w and w are strategic substitutes

A1 B2

wB1 wB2 wA1

Implication MA and R1 jointly prefer for MB and R2 to set higher wB2

Second Result: Intuition

Implication Exclusion of MA is no longer possible

The effect is stronger,

the stronger A and B compete at R1 and R2 R1 removes only B

MA MB R1 R 2

this relaxes constraint

1 B1B2

F ≤ П (R carries A) – П (R removes A)

B1B2

̃

A1 1

this reduces joint profits of MB and R2 from deviating

П

is lower

B2 d

Result When intensity of inter‐brand rivalry between retailers is strong, it is optimal to set F = 0

A1

Second Result: Intuition

• r

where When F = 0, then S is used to redistribute gains from trade between MA and R1

A1 A1

d = u +

R1|MB R1 |MA

u – uR1|MB

B1

λ + u +

MB|R 2

u – u

B2

(1 – λ )

MB|R 1 MB|R 2

S = (1 – λ ) GT – π

A1 A1 A1 MA

if GT is large

A1

S = GT – – π

A1 A1 MA R1 |R2

u – u R1|MA

B1

λ

if GT is low

A1

GT = П(w , w , w ) – d

B2 A1 A1 B1

* *

gains from trade between MA and R1

Second Result: Intuition

Result MA may pay slotting fee to compensate for negative impact

• f sales of its product on total sales of B.

< 0 if MA has weak bargaining power (unsurprising)

S = (1 – λ ) GT – π

A1 A1 A1 MA

Implication S can be negative

A1

S = GT – – π

A1 A1 MA R1 |R2

u – u R1|MA

B1

λ

< 0 if A sufficiently reduces total sales of B

̃

= П – d +

B1B2 R1 |R2

u – u R1|MA

B1

λ

Third Result

In a framework of sequential contracting, there do not always exist SPNE in which retailers carry the products of all their respective suppliers

Main Result There always exist CA‐SPNE with all links being active

Contrast with literature

Intra‐brand competition only

MB R1 R 2 MA MB R1

Inter‐brand competition only

Third Result: Intuition

a party negotiating with two counterparties cannot fully

appropriate benefits of individual trade with each of them

this effectively increases that partyʹs outside option of

failing some negotiation

this makes it difficult to sustain equilibrium with all

trading links

A1

GT ≥ max 0,

R1 |R2

u – u R1|MA

B1

λ

Formal Condition

Policy Implications

Impact of slotting fees (on prices) may be less anticompetitive when competition exists at both levels (monopoly outcome is not sustained) Slotting fees may be used to ensure that retailer does not remove manufacturerʹs product from its store