Assessing the anticompetitive effects of multiproduct pricing

1. Assessing the anticompetitive effects of multiproduct pricing Dennis Carlton, Patrick Greenlee, Michael Waldman April 2008 The views contained herein are my own, and do not necessarily reflect the views of the U.S. Department of Justice.

2. Outline • Review rationales and effects for “linked” pricing (bundling, tying, loyalty discounts) • Discuss discount allocation approach for bundled loyalty discounts • Present alternative approach for looking at linked pricing

3. Economies of scope active ingredients in cold medicine optional equipment for automobiles Preservation of quality Specify inputs to maintain proper function, and reputation Improved product mix in variable proportions settings durable goods and maintenance Rationale #1: Efficiencies in production or selling, improved product mix

4. Rationale #2: Price discrimination • Metering • Durable goods and consumables • Printers and toner cartridges • Reducing variance of demand • Uniform price extracts larger fraction of surplus • Block booking of movies • Sorting customers • Set different prices for different bundles • Outbound and return air flights

5. Rationale #3: Increase product differentiation • Tying a homogenous product (B) to a monopoly product (A) creates product differentiation: • Consumers that like A will purchase AB from monopolist. • Consumers that do not like A will purchase B from rival firm. • Tie/bundle allows monopolist to commit not to compete aggressively in B for customers that do not like A.

6. Rationale #4: Monopolize tied good market • One monopoly rent critique • For two goods (A, B) used in fixed proportions, an A-monopolist cannot profitably create a B-monopoly via tying. • Reason it can fail • If B has uses other than with A, and there are scale economies with B, then tying can profitably exclude rivals from the B market.

7. Rationale #5: Maintain tying good monopoly Assume the two goods are complements. • Eliminate inferior version of tying good • Tying denies scale to all rival sellers of tied good. • This causes rival seller of tying good to exit. • Defeat later entry into tying good • Tying denies scale in tied good, so no entry. • Given this, would-be entrant does not enter tying good market because it cannot cover fixed costs. • Raise rivals’ costs • Tied good is essential complement • Durable goods and their maintenance

8. Rationales #4 and #5: Exclusion • These stories include economies of scale/scope for the entrant • manufacturing (including fixed entry costs) • switching costs in dynamic settings • Absent such effect, denying sales to a rival firm does not alter the rival’s effectiveness • Suggests presence of scale/scope economies for entrant is a necessary element for such theories.

9. Rationales #4 and #5: Exclusion What about scope economies for the dominant firm? • Should encourage scope economies across goods (Rationale #1). • Are scope economies attainable without tie? • Balance harms and benefits?

10. Bundled Loyalty Discounts • Pricing scheme that includes tying as a special case • Buyer that is X% loyal in B gets a discount on each purchased unit of A. • If X = 100% and the undiscounted price for A exceeds the choke price, then the discount is economically equivalent to tying • A is tying good, B is tied good • Consumer gets A only if she buys B exclusively from the firm selling A

11. AntitrustModernization Commission Report Proposes the following approach: • Allocate discounts for bundle to the competitive product and check whether dominant firm sold competitive product below incremental cost • Show that the dominant firm likely can recoup these short-term losses • Show that the bundled loyalty discount program adversely affects competition

12. Example B competitively supplied: pB = cB = 5 Monopolist: charges pA = 12 loyalty program: (pA = 10, pB = 6) (consumer that buys B only from monopolist gets discount of 2 on A) Applying the AMC test: Total cost of B: cB + discount on A = 5 + 2 = 7 Price of B: pB = 6 Since cost exceeds price, firm fails test. Why offer a discount of 2 on A and receive only a premium of 1 on B?

13. Comments on AMC Approach - 1 1. This is a predation test: • Does cost of incremental volume exceed price? • What is the proper increment? • With discontinuous pricing, can often find an increment that is sold at a negative price. 2. Can construct examples where firm flunks test, yet surplus increases (and vice versa) • Price discrimination • Should not be a test, maybe a safe harbor

14. Comments on AMC Approach - 2 3. Recoupment requirement makes no sense (or is vacuous) • Loyalty discounts do not require profit sacrifice 4. How does one show that competition has been adversely affected?

15. An Alternative Approach - 1 Required elements: • Scale economies in tied good (B) • Market power in tying good (A) • Does the price of B increase for consumers that do not buy A? • Is the rival firm still in the market? Has its marginal cost increased?

16. An Alternative Approach - 2 Offsetting efficiencies: Are there scale/scope economies from tying? Are they not attainable in another fashion? […tough question]

17. Apply to LePage’s • LePage’s claimed scale economies are important, but offered no evidence. • 3M has market power in transparent tape. • LePage’s offered no clear evidence about increased prices for tape. • LePage’s purchased by another firm (Conros), still selling tape.