Evolutionary economics: an alternative approach to competition policy -

1. Evolutionary economics: an alternative approach to competition policy - the case of automobile distribution Simonetta Vezzoso University of Trento, Italy

2. additional arguments for anti-competitive effects of vertical restraints? evolutionary approachesto competition additional arguments for positive effects of vertical restraints?

3. ABOUT THE NOTION OF VERTICAL ARRANGEMENTS AND RESTRAINTS limited number of dealers sale only approved dealers PRODUCERS sale price CONDITIONS competitingproducts buying actual sources of supply purchase price DEALERS price territory resale customers sale to other dealers etc.

4. THEORETICAL ANALYSIS OF VERTICAL RESTRAINTS „OLD“ HARVARD SCHOOL CHICAGO SCHOOL efficiencies Chicago „MODERN“ ECONOMICANALYSIS TCE Agency market power „new“ Harvard

5. „economic approach“ aim of enhancingconsumer welfare efficient allocation of resources GUIDELINES recognition ofefficiencies ofvertical restraints vertical restraints possiblyanticompetitive only if market power BER 2790/1999 exemption up to 30% market share core restrictionsnot exempted

6. MOTOR VEHICLE SECTOR BER 123/85 BER 1475/95 cars less of a „special good“ Report closing-off of newdistribution techniques differences amongsale prices in member States BER 1400/2002

7. BER 1400/2002 exemption depending onmarket share threshold core restrictions stricter than BER 2790/1999 no cumulation of exclusive andselective distribution link between sales and service broken reinforcement of multi-branding more protection of dealers‘ economic independence

8. neoclassical theories ofcompetition evolutionarytheories ofcompetition APPRAISAL OFTHE NEW POLICY INNOVATION OF DISTRIBUTIONFORMATS - innovation and learninghardly taken into account innovation and learning occupy a central position - focus on competition as a discovery,innovation process - focus on price competition and the efficient allocation of resources SUITABLE THEORETICAL FRAMEWORK ? ADDITIONAL ARGUMENTS? NEED FOR A DIFFERENTTHEORETICAL FRAMEWORK ?

9. evolutionary approaches to competition Schumpeter/ Neo-Schumpeterian competition new products Hayekian and Austrian new services motor of economic development new technologies Resource literature changes new organizations from within the economic system unexpected, unforeseable market imperfections as part of competition market processes evolutionary processes of variation and selection importance ofvariation biological evolution theories influences behaviouralist organization theory

10. subjective Schumpeter/ Neo-Schumpeterian knowledge dispersed (local) Hayekian and Austrian difficult to communicate Resource literature individual knowledge problem system competition asdiscovery procedure

11. competition as a process • evolution of the economic system depending (also) on competition key insights about competition • creativity and heterogeneity of economic agents as a key to diversity • subjectivity and dispersion of knowledge • trial, error and discovery for knowledge‘s growth

12. GENERAL PERSPECTIVE ON MARKETPROCESSES OVER SEVERAL MARKET STAGES evolutionary variation and selection processesin vertically linked markets P P P P selection variation h1 h4 h2 h3 gatekeeper D D D D selection Consumers

13. P P P P D D D D variation h1 h2 h3 h4 selection Consumers

14. P P P P h2 h3 h1 h4 selection variation D D D D Consumers

15. P P P P matter ofdiscovery division oflabour D D D D organizational innovations Consumers

16. P P P P D D D D Consumers

17. evolutionary theoretical framework New perspective vertical restraints are part of these very complexand mutually interdependent processes of experimentation on different markets in the vertical chain

18. firms as bundles of resources complementarities among resourcesdecisive for competitive advantage Schumpeter/ Neo-Schumpeterian competition strategies Hayekian and Austrian Resource literature • - resource diversification - resources combinations • resources protection • imitation of successful resources firm‘s growth depending on its own capabilities

19. EVOLUTIONARY ARGUMENTS FOR ASSESSING VERTICAL RESTRAINTS/1 Subjectivism, Heterogeneity, and Local Knowledge • All firms within the vertical chain have subjective, fallible, and often local or tacit knowledge • this is neglected in neoclassical analyses of vertical restraints • Heterogeneous and local knowledge: • retailers might have superior knowledge compared to manufacturers • vertical restraints (e.g., selective distribution systems) may restrict retailer's freedom to make its own decisions on the basis of its specific knowledge • Consequence, e.g.: • "Protection of the freedom" of the dealers can lead to a more efficient distribution

20. EVOLUTIONARY ARGUMENTS FOR ASSESSING VERTICAL RESTRAINTS/2 Freedom to Experiment and Variety • Vertical restraints can restrict the freedom to experiment and reduce the amount of variety that is being generated and tested • Vertical restraints reduce the independent sources of innovation • Independent variation and selection processes on the producer and retailer level may lead to more generation of knowledge than in the case of (partial) vertical integration • several independent variation and selection processes within the vertical chain might improve the quality of the experimentation process • smaller bundles of hypotheses that are tested in the market improve the quality of the selection process • Consequences, e.g.: • intrabrand competition as an experimental process can be important, even if interbrand competition is effective • less vertical restraints might lead to positive innovation effects, and might also alleviate market entry

21. EVOLUTIONARY ARGUMENTS FOR ASSESSING VERTICAL RESTRAINTS/3 Communication Costs • Communication costs can be very high: • knowledge difficult to articulate and communicate • limited capability to absorb • Advantages of vertical restraints: • e.g., long-term exclusivities, may help establishing a climate supportive to a fruitful communication (reduces cognitive distance) • leading to improved division of labor between firms contributing heterogeneous knowledge-bases

22. EVOLUTIONARY ARGUMENTS FOR ASSESSING VERTICAL RESTRAINTS/4 Complementarity and Vertical Leadership • Interdependencies / complementarities between activities and competences can justify vertical restraints aiming at ex-ante qualitative coordination • vertical arrangements as means for discovering new complementarities and synergies • Systemic character of innovations can justify vertical restraints • innovation of complex products might require simultaneous innovations of many components • necessary: system (or vertical) leadership for the coordination of innovations • vertical restraints as a means by which the "hub“ exercises its coordinating role • alternative option: modularization through defining of interfaces ("interconnection knowledge"), within which independent experimentation is possible • Competition for vertical leadership • vertical restraints should not allow the vertical leader to perpetuate its power by • unduly restricting the other party‘s freedom to experiment • making entry more difficult • ensuring that competition for vertical leadership remains possible

23. competition asevolutionary variation and selection processesin vertically linked markets evolutionaryperspective firms as a bundles of resources (capabilities, heterogeneous knowledge) evolutionary argumentsconcerning vertical restraints new policy in the car sector positive effects of the newer rules on evolutionary competition?

24. unbundling of sale and repair services retailers heterogeneous in regardto their knowledge and skills better if they found by themselves if outsourcing is an efficient choice also because of similaritiesof knowledge and skills vertical rivarly between dealers and retailers lowering of entry barriersinto the retail market new firms need not offersimultaneously distributionand repair services

25. more protection of dealers‘ economic independence step to a long-term development ? really independent dealers of emerge that can develop their own innovative distribution formats and test them on the market ?

26. Is the new policy sufficient to break up thetraditional distributionstructures? OPEN QUESTIONS MORE e.g. no cumulation of exclusive andselective distribution should selective distributionbe prohibited ? retailers free to sellthe products the way they think more appropriate ? important for the producer tochoose whom to sell his items also because of possible synergies between resources/ competences important that other, independent dealers emerge

27. Evolutionary arguments against vertical restraints Evolutionary arguments in favour of vertical restraints: • improved communication between firms with heterogeneous knowledge-bases • ex-ante qualitative coordination of interdependent / complementary activities and resources • better coordination of innovations in the case of systemic innovations • limitation of the freedom to decide on one's subjective, local knowledge • freedom to experiment restricted • less variety generated and tested • restriction of competition for vertical leadership

28. Problems of Regulating Vertical Restraints from an Evolutionary Perspective • Knowledge problems of competition authorities: • lack of specific information and foreseeability of market processes • very difficult to decide correctly in single competition cases • consequence: "per-se rules" are better than a "rule of reason", but which increasingly is the tendency in EU competition law • Knowledge problems of firms in regard to vertical restraints: • positive efficiency effects of new vertical restraints due to organizational innovations cannot be predicted ex-ante • rule of reason under Art. 81 (3) is difficult to apply • But: 30% market share as "safe harbour" in Block Exemption Regulation allows for free experimentation • no need to substantiate efficiency benefits ex-ante or ex-post

29. CONCLUSIONS • evolutionary theories should complementneoclassical competition theories • possible to identify additional arguments in favour of vertical restraints • from an evolutionary perspective • possible to identify additional argumentsagainst vertical restraints from anevolutionary perspective • more research needs to be done! also, better understanding ofhow evolutionary competitionworks (i.e. conditions, etc.)

30. EXAMPLES OF POSSIBLE RESEARCH TOPICS how much diversity/heterogeneity among actors do we need for evolutionary competition to work? is the „relevant market“ notion still important in an evolutionary context? does resale price maintenance negatively affect evolutionary competition at the retail level? how important is price flexibility to provide retailers with innovation incentives? do vertical restraints distort vertical competition? how do we combine the governance (efficiency) and the competence perspectives on vertical arrangements forthe purposes of competition policy?