The Nature of Vertical Restraints

Abstract

Total Surplus is the best metric for social welfare. It is the sum of Producer, Retailer and Consumer Surplus (See Diagrams) – not just the sum of Producer and Consumer Surplus as assumed in most economists’ models that make the false assumption that the retail sector is perfectly competitive in categories with differentiated products.There is an inverse association between the margins of manufacturers and retailers with both strong and weak brands. With strong brands consumers are more disposed to switch stores within brand should a retailer fail to carry the brand or price it competitively. Manufacturers have high margins and retailers thin ones. With weak brands consumers are more disposed to switch brands within store, and the margin relationship is reversed. But Bowman’s mutual dependence scenario in which there is only modest market power at both stages encourages RPM where margins at both stages are elevated and thus positively related.Competition has both a vertical and a horizontal dimension. There is both a complementary and a competitive relationship between firms in a vertical relationship.The Chicago School attributes differences in retailers’ prices to free riding, but the differences have often due to the greater efficiencies embodied in a succession of new retailing formats.When the Agencies have brought actions against a powerful manufacturer that had adopted vertical restraints, social welfare has typically been advanced. But actions against weak brands are pointless, because they cannot produce beneficial welfare outcomes.The article presents the views of many contributions to the literature including, Bork, Posner, Scherer, Bowman, Palamountain, Schumpeter, Baxter Chamberlin, Easterbrook, Bordon, Salop, Scheffman, Fogg-Meade, Marshall, Hefflebower, Grether, Overstreet, Lee, Corey, Marvel, Oster, Telser, Seligman, Bonoma, Bucklin, Yamey, Pickering and Pitofsky.The article examines Monsonto, Colgate, Schwinn, Schwegmann, General Electric, Russell Stover, Corning, Levi Strauss as well as case studies of RPM and non-price vertical restraints in Lydia Pinkham’s Vegetable Compound, Light Bulbs, and in the U.K.