Buyer Power and Competition Policy Roman Inderst University of Frankfurt / Imperial College London

1. Buyer Power and Competition PolicyRoman InderstUniversity of Frankfurt / Imperial College London

2. Literature References • Buyer Power in Distribution (ABA Antitrust Section Handbook) • The Role of Buyer Power in Merger Control Distribution (ABA Handbook) • Where Buying and Selling Power Come Together: The Waterbed Effect (Wisconsin Law Review 2008) • Differential Buyer Power and the Waterbed Effect (ECLR 2007) • Some Economics on the Treatment of Buyer Power (ECLR 2006) • Countervailing Power and Dynamic Efficiency (JEEA 2008) • Buyer Power and the Waterbed Effect (J Ind Econ 2010) • Third-Degree Price Discrimination with Buyer Power (B.E. Journal 2009) • Market Power, Price Discrimination and Allocative Efficiency (Rand 2009) • Price Discrimination in Input Markets (Rand 2009) • Leveraging Buyer Power (IJIO 2007) • Buyer Power and Supplier Incentives (EER 2007) • Retail Mergers, Buyer Power and Product Variety (Ec. Journal 2007) • Bargaining, Mergers and Technology Choice (Rand 2004)

3. The Topicality of Buyer Power • Distribution activity is relatively under-researched in Industrial Organization. • But it was key to shape antitrust laws in the past. • Recent cases (Rewe/Meinl, Kesko/Tuko, Carrefour/Promodés)Sector inquiries (eg, CC 2008)Roundtables (eg, OECD 2008)

4. The Framework of Analysis • Monopsonistic / “Market Interface” perspective: • Mirror image of seller power vs. final consumers • Exercise of market power through withholding demand. • Bargaining perspective: • Most clear-cut form: Efficient bilateral negotiations • Key levers of buyer power: “Outside options” • “Hybrid cases” also relevant in practice • Eg, bargaining over or auctioning of limited “slots”, “single-sourcing” contract etc. (Inderst/Shaffer EJ 07)

5. Framework ` Key Point 1:In many settings, in particular if relatively few suppliers and buyers interact, buyer power is not likely to lead to the strategic withholding of demand. Instead, it is primarily targeted at the realization of individual discounts. Bargaining theory provides an adequate and flexible tool to capture this.

6. Theories of Buyer Power • Does “raw size” matter? • Benchmark: Unrelated negotiations. • But may enhance a buyer’s outside option (sophistication, costs of switching suppliers, etc.) (Inderst IJIO 07) • But also opposite predictions? • Free-riding on “pivotal role” of a critical buyer? • Larger costs of “moving large volume”? (Inderst/Montez 2011)(Response: Second sourcing!)

7. Theories of Buyer Power • Buyer size and suppliers’ outside option • Controlling potential market: Gatekeeping (Inderst/Wey EER 07) • Economic dependency ?

8. Measures of Buyer Power • Careful: • At least “below dependency thresholds”, absolute values should matter, not percentage values! • Inflicted loss and not lost business counts. • OECD (1998): “... E.g. Retailer A has buyer power over Supplier B if a decision to delist B’s product could cause A’s profit to decline by 0.1 per cent and B’s to decline by 10 percent.” • If size is chosen as a measure, which threshold? • Should be informed by theory of harm. • Difference to seller power: Justification of two-stage approach?

9. Thresholds No general recipe! Eg, two views 1) Choice of threshold can not be guided by general presumption of a clear link between BP and harm Higher threshold? 2) In bilateral relationship, already low fraction of supplier’s business (20%) can give rise to substantial BP Lower threshold?

10. Measuring of Buyer Power Key Point 2: A buyer’s size, both in absolute terms and as a fraction of a particular supplier’s existing business or his potential market, can but need not provide a good measure of buyer power. “Mechanical use” of pure-size or “dependency” comparisons is potentially misleading. In contrast to horizontal analysis, threshold can not be guided by the presumption of a clear link between buyer power and consumer harm.

11. Implications and Potential Harm • Short-run impact on retail prices?Consumer champion? • Criticism: Efficient contracting? No pass-through? • But: Short- vs. Long-term? Plow back savings into lower prices, better offers?

12. Implications and Potential Harm • More generally:How appropriate is the “efficient negotiations” framework? Does it imply marginal-cost pricing? • Above cost pricing to reduce intrabrand competition Can lead to “waterbed effect” • Strategic wholesale pricing to affect profit-sharing in chain by reducing profits from “substituting away”(Inderst/Shaffer, in progress)

13. Potential Harm (cont.) • Effect on competing buyers? • Exit / “Spiral” Long-term consequence? Entry? • “Waterbed effect”? Possibly already in short term. • “Logical consistency” of the waterbed effect?

14. Waterbed (Inderst/Valletti JIE 2010) • Generating discounts: Fixed costs F of “switching”. • Benchmark: Independent retailers • In some market n, retailers An and Bn. • In a Hotelling setting, equilibrium: • Outside option payoff for An: • Offer from the (incumbent) supplier:

15. Waterbed (cont.) • Additional discount for larger retailer generated after • either acquisition of additional outlets, • or “organic growth” in given market (lower marginal costs). • Model generates conditions for: • Retail price at small/independent outlets up if • Average retail price up if

16. Implications for the Upstream Market • Consolidation? (cf. evidence in Inderst/Mazzarotto 08) • Theoretical foundations? Less disincentives to merge? • Reduction in incentives to invest and innovate?(Hold-up problem?) • But: Large/dominant buyers may mitigate underlying contractual problems. • But: For incremental investments incremental profits and not absolute profits are decisive. Larger/more powerful buyer may increase incremental benefits for innovation/investment (“keep suppliers on toes”) (Inderst/Wey JEEA 09)

17. Example Supplier Incentives • Logic: When downstream firms merge, at “break-down” seller must replace a larger quantity Affects incentives to choose technology / invest in process innovation Affects incentives to invest in product innovation • Example: Make product more “versatile”, demand at other buyers less elastic Sell larger volume at other buyers without much reduction in price

18. Buyers’ Incentives (Inderst/Valletti Rand 09) • Example: Incentives to reduce own marginal cost k. • Benchmark: Buyer monopoly • Buyer downstream competition

19. Implications of Buyer Power Key Point 3: In the short run, lower retail prices depend on the “form of contracts” and the absence of a “waterbed” effect. In the long run, upstream incentives to invest and innovate may not necessarily be lower for suppliers. And higher for buyers when they can lever size into lower wholesale prices.

20. Policy: Protecting Suppliers? • What are “exploitative terms”? • Long delay of payments? • Retrospective reductions in price? • Unless bargaining power is structurally affected, rent extraction will be less efficient after intervention? • Seemingly exploitative terms may be outcome of efficient contracting. • “Quasi-judicial” function of large retailers?

21. Economic Dependency • Benchmark 1: TIOLI-offer of monopsonistic buyer Full extraction of (efficiency) rents. • Benchmark 2: Buyer runs a non-discriminatory „procurement auction“ Proposal: „Safe Harbour“ in dependency cases. • Features: • Different buyers may obtain different deals. Respecting their different outside options. • But more efficient suppliers can extract efficiency rents as well. • Preserves „essence of competition“. Going beyond this risks severe dynamic inefficiencies.

22. “Safe Harbour” • Motivation: German §20 GWB Objective to protect competitive process but also dependent counterparties • Redistribution of profits (in vertical chain) based not on „economic merit“ but „power/dependency abuse“? No „pass-on“ defence! • Analogy: Monopolistic supplier vis-á-vis final consumers • Case 1: Supplier makes TIOLI offer • Case 2: Consumers make offer to supplier

23. Summary: BP as “Offence” Is Economic Theory of Any Help? • Role 1: To question “short cuts”. • Eg, in criticizing narrow “hold-up” perspective on investment incentives. • Role 2: Constructive. • Eg, conditions on when harm more/less likely. • What is still missing: • In particular, set of workable measures of buyer power.

24. BP as Defence in Mergers (Omission) • Procurement efficiencies? • Contracts / Pass-through? • Specific? • Countervailing Power: • Broad Shield? • Coalescing Power?

25. Buyer Power and Competition PolicyRoman InderstUniversity of Frankfurt / Imperial College London