EU law bans any agreement between firms
intended to prevent or distort competition.But ‘selective and exclusive
dealerships’ the arrangements which govern all new car sales, are exempt under
what is known as Rule 123_85. A typical European new car dealer offers models
of only one make, or a few select makes. The customer cannot cross the street
and buy the same car more cheaply because, by agreement, the next dealer will
probably be located several miles away. The rule also applies to spare parts.
Manufacturers can refuse to sell to wholesalers or can ‘advise’ their equipment
producers against reaching agreements with them unless certain terms are
agreed.
SEDs are examples of what economists call
vertical restraints. Vertical restraints
involve agreements between
producers of complementary goods. They are distinguished from horizontal
restraints which relate to agreements between producers of the same good or
close substitutes. Thus if a car manufacturer places a limit on what retailers
sell and how they sell the product, that is a vertical restraint. Agreements between
car manufacturers themselves as regards price or market share is a horizontal restraint.
Generally, vertical restraints are considered innocuous for competition. By
contrast, there is a presumption that horizontal restraints are
harmful to competition.
An SED typically specifies what retailers
sell and how they sell it. Under ‘selective
dealership’, a producer
uses only those retailers who agree to support its brand in specified ways –
perhaps by giving information to potential customers or providing aftersales service
to those who buy. ‘Exclusive dealerships’, as the name suggests, commit retailers
to selling one brand. They often go hand-in-hand with ‘full-line forcing’,
under which retailers stock a manufacturer’s whole range, not just one or two
products.
Other vertical restraints include
‘exclusive territories’, which limit a retailer’s sales to a particular area and ‘franchise fees’, which are sometimes paid
to manufacturers for the right to sell their wares or to put their logos above
the shop door .Producers may also try to fix retail prices, either by
controlling discounts or by demanding that retailers sell minimum quantities of
their products.
At first sight, these devices look like a
conspiracy against consumers. But sometimes they can benefit the consumer,
because contracts with vertical restraints are often the most efficient way for
producers to get their products to the customer and to ensure good after-sales
service.
A manufacturing firm can sell through an
independent retailer or by setting up its
own retail network.
Independent retailers have stronger incentives than employees to
maximise retail profits
and they may know more about local markets.
However, retailers may set prices higher
than producers would like.Suppose producers sold their goods to retailers at a
uniform wholesale price. If retailers
have some monopoly power
in their local markets, they can set retail prices above
wholesale prices .But
manufacturers would like prices to be lower: that would expand retail sales,
reduce unit costs, and boost the manufacturer’s sales and profits. One of
several ways around this is to set up a SED, i.e. insist that retailers pay a
franchise fee for the right to sell the product and, in return, cut wholesale
prices.
Payment of a franchise fee
does not affect the dealer’s profit-maximising level of sales. But a lower
wholesale price does, and gives an incentive to the dealer to cut the retail price
and raise sales volume.
Complaints against vertical restraints
might still be valid in that consumers’ range of choice is being restricted.
However, if there are many competing producers, retailers, even with exclusive
territories, do not have much market power. While they face no competition from
others selling the same brand, other local retailers are selling competing brands,
curbing their ability to exploit consumers.
Hence the rationale for exempting SEDs
under the competition regime. This exemption has been extended to 2004. Current
economic thinking stresses the importance of market structure. The more
competition between brands, the more likely that pro-competitive and efficiency
effects of vertical restraints will outweigh any anticompetitive effects.
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