The Economics of Exclusionary Behaviour Massimo Motta EUI, April 2007 - PowerPoint PPT Presentation


PPT – The Economics of Exclusionary Behaviour Massimo Motta EUI, April 2007 PowerPoint presentation | free to view - id: ff059-YjU2M


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation

The Economics of Exclusionary Behaviour Massimo Motta EUI, April 2007


... investment in capacity (Dixit) Tying (Whinston) Exclusive ... (Dixit, 1980) ... Notes from Motta (2004: 457-60); inspired by Spence (1977) and Dixit (1980) ... – PowerPoint PPT presentation

Number of Views:152
Avg rating:5.0/5.0
Slides: 63
Provided by: www2Ds8


Write a Comment
User Comments (0)
Transcript and Presenter's Notes

Title: The Economics of Exclusionary Behaviour Massimo Motta EUI, April 2007

The Economics of Exclusionary BehaviourMassimo
MottaEUI, April 2007
  • Why is it an important topic?
  • Many situations where markets are dominated by a
    firm which may use its market power to exclude
    smaller rivals, relegate them into niche
    position, or deter entry
  • Fresh attention
  • Liberalisation and privatisation processes have
    created asymmetric market structures with strong
  • Growing importance of sectors which exhibit
    network effects
  • Very difficult topic in anti-trust
  • To distinguish exclusionary practices from tough
    competition is not an easy task (long and
    complex investigations and trials)
  • Currently, hot debate in both US and EU

Article 82 of the EC Treaty
  • Any abuse by one or more undertakings of a
    dominant position within the common market or in
    a substantial part of it shall be prohibited as
    incompatible with the common market insofar as it
    may affect trade between Member States.
  • Such abuse may, in particular, consist in
  • (a) directly or indirectly imposing unfair
    purchase or selling prices or other unfair
    trading conditions
  • (b) limiting production, markets or technical
    development to the prejudice of consumers
  • (c) applying dissimilar conditions to equivalent
    transactions with other trading parties, thereby
    placing them at a competitive disadvantage
  • (d) making the conclusion of contracts subject to
    acceptance by the other parties of supplementary
    obligations which, by their nature or according
    to commercial usage, have no connection with the
    subject of such contracts.

Possible classification
  • Pricing abuses
  • Predatory pricing
  • Price squeeze
  • Rebates
  • Discriminatory pricing
  • Non-price abuses
  • Commitment to aggressive pricing
  • Over-investment in capacity
  • Product Proliferation
  • Bundling and tying (Whinston)
  • Increasing rivals costs
  • Exclusive Dealing
  • Refusal to supply, interoperability decisions
  • .

Plan of the lectures
  • Models of predatory pricing, esp.
  • Reputation models (Kreps-Wilson)
  • Financial market models (Bolton-Scharfstein)
  • Commitment models
  • Over-investment in capacity (Dixit)
  • Tying (Whinston)
  • Exclusive Dealing
  • Exploiting externalities across buyers
  • To extract rents from entrant (Aghion-Bolton)
  • Rebates and price discrimination
  • Interoperability decisions (Crémer-Rey-Tirole)
  • If time allows
  • Tying in network markets Carlton-Waldmann
  • Pro-competitive effects of exclusive dealing

Predatory pricing see separate pdf file
Non-price exclusionary strategies
  • Commitment to make it credible aggressive pricing
    in case of entry (stay)
  • Over-investment in capacity
  • Product proliferation
  • Bundling
  • ..
  • Increase of the rivals costs
  • Exclusive dealing
  • Over-investment in advertising
  • Refusal to supply..

Over-investment in capacity
  • (Dixit, 1980)
  • The incumbent installs larger capacity wrt a
    monopolist which does not face threat of entry.
  • Why? If capacity is scarce, incentives to
    undercut rivals are weak (demand attracted from
    rivals cannot be satisfied).
  • Large capacity makes it credible that competition
    will be very tough in case of entry Entry
  • Ex. DuPont and the Titanium Dioxide Industry.
  • N.B. Investment choices must be irreversible!
  • Difficult to distinguish from
    innocent investment.

Strategic investments to deter entry
  • Notes from Motta (2004 457-60) inspired by
    Spence (1977) and Dixit (1980)

The model
  • Firm 1 Incumbent. Firm 2 Entrant
  • Homogenous good industry, with p1-q
  • The game (to be solved backwards as usual)
  • (i) 1 invests to x1 to reduce costs (c- x1) q1.
  • Cost of investment x12. Entrant does not
    invest, and has cost c.
  • (ii) Entrant enters or not. Sunk cost of entry
  • (iii) Each active firm chooses output.

Solving the model last stage
  • If duopoly each firm max
  • where c1c-x1 and c2c.
  • Reaction functions are
  • Solving gives
  • If monopoly, optimal values are

Solving the model (contd)
  • 2nd stage Firm 2 enters if net profits are
  • 1st stage. Two different cases.
  • Firm 1 behaves innocently, i.e.
  • By solving, we obtain
  • Therefore, if Fgt(1-c)2/25, entry is blockaded.

Solving (contd) strategic behaviour
  • (ii) Firm 1 behaves strategically.
  • Note that firm 2s profits decrease with F.
  • There exists a value x1p1-c-3F1/2 such that if
    firm 1 invests x1p then p2p 0. Then, investing
    slightly above x1p firm 2 will prefer not to
  • See figure 7.5 for intuitions.
  • Entry deterrence is feasible.

Figure 7.5. Entry-deterring RD
Is entry deterrence profitable?
  • If firm 1 invests x1p it will be a monopolist,
    and will earn
  • We then have to check if p1pgt p1inn.
  • By studying this inequality one sees that
  • F4(1-c)2/625, accommodated entry
  • 4(1-c)2/625ltF4(1-c)2/25, deterred entry
  • Fgt4(1-c)2/25, blockaded entry.

Is entry deterrence anti-competitive?
  • Since it leads firm 1 to invest too much and
    lower its costs, entry deterrence is not
    necessarily bad.
  • It can be checked that
  • F4(1-c)2/625, accommodated entry
  • 4(1-c)2/625ltF4(1-c)2/225, deterred entry, but
    consumer surplus is higher
  • 4(1-c)2/225ltF4(1-c)2/25, deterred entry, but
    consumer surplus is lower
  • Fgt4(1-c)2/25, blockaded entry.

Product proliferation
  • Incumbent produces a high number of varieties
    (larger than short-run optimal).
  • Why?
  • If entry, the entrant forced to produce varieties
    close to the incumbents ones.
  • Low differentiation tough price competition
    entry unprofitable.
  • N.B. Variety choice must be irreversible!
  • Example US market of ready-to-eat breakfast

Tying and Bundling
  • Tying
  • the purchase of one good (tying good) is
    conditional upon the purchase of another good
    (tied good).
  • N.B. the tied product may be bough alone.
  • Ex. computer and OS newspaper and DVD.
  • Requirement tying goods sold in variable
  • Ex. printer and toner photocopy machine and
    after-sale services mobile telephone and calls.
  • Bundling
  • two goods are sold together
  • Pure bundling goods available only together
  • Ex. newspaper and supplement
  • Mixed bundling goods available also separately
  • Ex. fixed menu and order à la carte.

Exclusionary bundling
  • Bundling can be used by a dominant firm to extend
    its monopoly into an adjacent market or to
    protect its position in the home market.
  • Independent products
  • Demand-side benefits from joint supply
  • Complementary products

Independent products
  • Bundling the two products, the incumbent commits
    to aggressive pricing if entry, thereby
    discouraging entry.
  • (Whinston, 1990)
  • Why?
  • In order to earn monopoly profits on market A, I
    must sell also in market B.

Simple model
  • Assumptions
  • Demand
  • Costs vgtcIA, wgtcIBgtcEB.
  • Sunk cost F to enter the market B. If entry,
    Bertrand comp.
  • cIB cEB gtF
  • v cIA-FBgt cIB - cEB .
  • Bundling is irreversible and requires a fixed
    cost FB.

Simple model
  • After entry decision, active firms name prices
  • If bundling and E out
  • If no bundling and E out
  • If no bundling and E in
  • If bundling and E in

Cont. eq, after bundling and E in
  • If , consumers
    buy good B from E.
  • If , consumers buy both goods from I.
  • Equilibrium . Consumers
    buy from I
  • An eq. where and consumers buy from I
    does not exist
  • E has incentive to deviate
  • An eq. where and consumers buy from E
    does not exist
  • I has incentive to deviate

Sub-game perfect equilibrium
  • Irreversibility is crucial for exclusion.
  • Given that E in, Is profits lower in case of
  • If bundling reversed without costs and in a short
    time, in case of entry I would reverse bundling.
  • Anticipating this, E would enter.

Under differentiated products
  • If products are differentiated, the strategic
    effect of tying can be seen by drawing reaction
    functions (see Motta, 2004 473 ff for model)

Bundling and Portfolio Effects
  • Consumers benefit from joint supply.
  • Bundling provides a competitive advantage over

Complementary products
  • Chicago critique bundling for exclusion
  • Why? The incumbent can earn at least the same
    without bundling.
  • Assumptions
  • B has no value if not consumed with A.
  • Utility from joint consumption U
  • With bundling
  • Entry does not occur
  • Without bundling
  • Entry occurs in market B

Complementary products
  • More generally, the dominant firm is interested
    in the provision of B by third parties at the
    lowest possible cost, since this will allow to
    extract more profits from market A.
  • Without bundling
  • Entry occurs in market B
  • Complementarity makes it less likely the
    exclusionary effect of bundling (but not

Complementary products
  • Choi and Stefanadis (2001)
  • Firms compete through upfront RD a potential
    entrant can enter if it succeeds in innovation
    and obtains a superior tech.
  • By irreversibly bundling the two products
    entering requires being successful in both
    innovation processes.
  • Expected return from entry in anyone market is
  • Incentives to innovate are lower potential
    entrants invest less entry less likely.

Complementary products
  • Carlton and Waldman (2002)
  • Initially threat of entry in market B.
  • Subsequently, threat of entry in market A.
  • Bundling prevents entry in market B less
    likely that entry will occur in market A.
  • By making entry in the adjacent market
    impossible, the incumbent tries to prevent entry
    in the home market.

Complementary products
  • Mechanism for exclusion
  • scope for entry in one market made dependent on
    success of entry in a complementary market.

Efficiency reasons for tying
  • Reduction of transaction costs for consumers.
  • Quality improvement.
  • Solution to information problems.

Price discrimination device
  • Simple example
  • Without bundling pA4 , pB5 p18
  • With bundling p12 p24

Price discrimination device
  • Requirement tying allows to sort consumers
    according to their intensity of use and make them
    pay accordingly.
  • Example copy machine tied to toner.
  • Demand for toner measures intensity of use.
  • Low price for the machine, high price for toner
    allows to price discriminate.
  • Welfare effects of price discrimination in
    general ambiguous
  • More likely to increase welfare when it attracts
    new consumers.

  • Per se prohibition not justified.
  • Rule of reason approach
  • Evaluate whether exclusionary effect exists
  • Irreversibility?
  • less likely if complementary products.
  • Entry in one market affects success of entry in
    another market?
  • Evaluate existence and importance of (potential)
    efficiency gains.

Exclusive dealing
  • Contract that commits a firm to deal exclusively
    with some vertically related firms but not with
  • Example a dominant seller prohibits buyers from
    dealing with competitors
  • A dominant seller commits to deal exclusively
    with one (or some specific) vertical related
  • Exclusive dealing may allow a dominant firm to
    deter efficient entry
  • Traditional argument.
  • Chicago school critique.
  • Recent theories.

Anti-competitive ED
  • Traditional argument
  • If ED, no entry firm E has nobody to sell to.

Chicago school critique
  • Why does the buyer agree on exclusivity?
  • Bs loss CS(cI)- CS(pm)xgtpm Is gain
  • If B rejects exclusivity
  • entry
  • pcI pBCS(cI) pI0
  • If B accepts exclusivity
  • no entry
  • p pm pBCS(pm) pIpm

Chicago school critique
  • The incumbent cannot (profitably) compensate the
    buyer to elicit acceptance.
  • The incumbent cannot (profitably) use ED to deter
  • ED will be signed only if mutually beneficial
  • Efficiency considerations explain the use of ED.

Upstream competition matters
  • If upstream competition weaker lower prices
    in case of entry.
  • Buyers requires less to sign.
  • The incumbent may profitably induce the buyer to
    sign and deter entry.
  • Example Cournot competiton between E and I.

But Upstream Competition Matters!
  • If weaker competition
  • Firm Is gain GJL-JGL
  • Buyers loss GH
  • I can induce B to sign if LgtH
  • (If buyer expects higher prices
  • after entry, it requests less
  • to sign ED!)

Externality on third parties
  • When a buyer signs an ED, some externalities are
    exerted on third parties.
  • By exploiting these externalities, the incumbent
    can profitably use ED to exclude.
  • (Rasmusen et al. 1991 Segal-Whinston 2000
    Bernheim-Whinston 1998)

Externality among buyers
  • Simple model
  • some (uncoordinated) buyers.
  • Individual demand insufficient
  • to cover (sunk) entry cost F.
  • if a buyer signs, negative externality on the
    other also the free buyer cannot purchase from

Simultaneous/non-discriminatory offers
  • Result 1 if downstream firms are final consumers
    (or independent monopolists), there exist both
  • EXCLUSIONARY EQUILIBRIA both buyers sign
  • Why? Individual deviation is not profitable
  • ENTRY EQUILIBRIA no buyer signs
  • Why? I cannot prevent these equilibria from
    arising (offering x to both buyers is not
  • Incumbent exploits coordination failures to

Simultaneous and discriminatory offers
  • Result 2 if downstream firms are final consumers
    (or independent monopolists)
  • Why? If both buyers reject, I deviates and
    offers x to one buyer only.
  • (Note there exists multiplicity of exclusion
  • Discriminatory offers facilitate exclusion

Discriminatory offers facilitate exclusion
Buyer 1
Buyer 2
If 2 pm gtDCS (i.e., BC), then the incumbent can
persuade one buyer, and therefore exclude the
entrant from both markets.
Sequential offers
  • Stage 1
  • Incumbent offers ED to buyer 1 (including
    compensation x1) no price commitment.
  • Buyer 1 decides whether to accept or reject.
  • Stage 2
  • Incumbent offers ED to buyer 2 (including
    compensation x2) no price commitment.
  • Buyer 2 decides whether to accept or reject.
  • Stage 3
  • Entry decision.
  • Stage 4
  • Active firms name prices.
  • Assumption 2pmgtx

Sequential offers
  • If at least a buyer signed Entry does not

Sequential offers
I offers x10
I offers x20
I offers x2x
Sequential offers
  • Buyer 2s decision
  • If B1 accepted,
  • B2 accepts behind x2gt0 (entry does not follow in
    any case)
  • The incumbent offers x20 and B2 accepts.
  • If B1 rejected,
  • B2 accepts behind x2 x.
  • The incumbent offers x2 x (2pm xgt0) and B2
  • Buyer 1s decision
  • Whatever it chooses, entry does not follow
  • It accepts behind x1gt0.
  • The incumbent offers x10 and B1 accepts.
  • In equilibrium both buyers accept behind
    negligible compensations profitable

  • Fumagalli-Motta downstream comp. matters!
  • - close substitutes cheaper input
  • strong competitive advantage
  • demand of a single buyer triggers
  • entry
  • the incumbent cannot profitably
  • compensate the buyer
  • - differentiated products cheaper
  • input
  • negligible competitive
  • advantage same as SW
  • Fierce downstream competition eliminates the
    anticompetitive effect of exclusive dealing

Rents extraction (Aghion and Bolton
non-stochastic version)
  • An incumbent can use exclusive deals to extract
    rents from entrants.
  • A simple exampleInelastic demand, q 1.

Game 1. I offers an exclusive deal with (x, d,
wI ), where x compensation d penalty
(liquidated damages) if deal terminated wI
price commitment. 2. Buyer B accepts or
rejects. 3. E decides on entry. 4. If entry,
E decides pE (and if no deal, I chooses pI.) 5.
B decides on termination (if had signed),
or on supplier (if free). Note. Here the buyer
is final consumer with willingness to
pay v and unit demand.
  • If buyer rejects, E enters and buyer buys at
  • Any contract should leave buyer with at least
  • If buyer accepts (x, d, wI ), it
    switches to E only if (or

  • Entry occurs only if .

Incumbent maximises its profits, by offering
x0, dcI-cE, wIcI. Buyer
makes csB v cI entrant makes
zero profit incumbent makes
The incumbent finds it
optimal to allow entry and use the EC and the
penalty to extract the efficiency rent
associated with entry. In this model, entry is
pre-empted only if Es cost is stochastic and I
makes mistakes in predicting Es costs.
Contracts as a barrier to entry (Aghion and
Bolton, AER 1986)
  • Assumptions
  • Incumbent I has cost cI1/2
  • B's valuation v1 (unit demand)
  • Potential entrant E cE unif. distr. in 0,1.
  • Exclusive deal (p,po) B will buy from I at price
    p, but it can buy from E if pays "liquidated
    damages" po.
  • The game
  • t1 firm I offers (p,po) to B, who accepts or
  • t2 firm E decides on entry and sets price pE.
    (If no contract, I chooses its price p)
  • t3 payoff realisation.

No exclusive contract
  • If cE lt1/2, E enters, sets pE1/2 and gets all
  • If cE1/2, no entry, I sets p1
  • Prob. of entry fPr(cE1/2)1/2
  • Buyer's surplus if entry v-pE1-1/21/2.
  • With probability (1-f), B has surplus v-pI0.
  • B's expected surplus (1/2)f(1-f)01/4.
  • I's expected payoff (0)f(1-f)(1-1/2)1/4.

Exclusive contract
  • B buys from E if pEpop if it enters, E sets
    pEp-po. ?Prob. of entry with contract
  • Incumbent's problem
  • maxp,popf'po(1-f')(p-1/2)
  • s.to1-p1/4.
  • B accepts only if better off than no
    contract (1/4)
  • maxpo p
  • p3/4, ?(p,po)(3/4,1/2).
  • Hence, firm E enters with prob. f' p-po 1/4.

Effects of exclusivity
  • Entry efficient if cE1/2, but occurs under the
    contract only if cE1/4
  • ?welfare loss for 1/4ltcE1/2
  • Does I offer this contract at equilibrium?
  • Yes p(1/4)(1/2)(3/4)(1/4)5/16gt1/4.
  • When E very efficient, I prefers not to deter
    entry (it extracts some of E's rent via t).

Efficiency reasons for ED
  • Protect and encourage relation-specific
  • Ex. stimulate producers investments into
    retailers services (free riding).
  • Promote retailer loyalty
  • Ex. encourage the retailer to tailor its
    promotional efforts towards the manufacturers
  • Maintain the value of the product
  • Ex. producer of a luxury good commits not to
    sell it through supermarkets not to damage the
    image of the good.

  • Per se prohibition not justified.
  • Rule of reason approach
  • Evaluate whether exclusionary effect exists
  • Buyers fragmentation?
  • less likely if upstream competition intense.
  • Less likely if downstream competition intense.
  • Important scale economies upstream?
  • Evaluate existence and importance of (potential)
    efficiency gains.

Increasing rivals costs
  • A vertically integrate firm may refuse to supply
    a key input to a downstream rivals.
  • Deny inter-operability to a rival network.