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About the article
Published Online: 2013-09-26
Economies of scale can occur at the overall production level or in fulfilling a specific order, but are less likely to relate to the total purchases of a customer over a certain period.
The EC guidelines require a dominant firm to provide an objective motivation for a discount scheme that can potentially make it harder for its rivals to compete: “It is incumbent upon the dominant undertaking to provide all the evidence necessary to demonstrate that the conduct concerned is objectively justified.” See paragraph 31 in European Commission (2009).
Lately, European and North American case law have focused on whether loyalty discounts can serve as exclusionary devices that would violate Article 102 of the EC Treaty or Section 2 of the Sherman Act. In addition, firms’ use of loyalty discounts in the distribution of their products has also been attacked as unlawful primary line price discrimination under the Robinson Patman Act and EC law (Art. 102c).
Mills (2010) and the Office of Fair Trading (2005) present comprehensive overviews of antitrust cases related to loyalty discounts in US and Europe. See also Kobayashi (2005), European Commission (2005, 2009), and Gual et al. (2005).
The term “all-unit” quantity discount is used to emphasize that we study rollback rebates. However, our setting also informs on the relative private desirability of “incremental-unit” quantity discounts (that do not rollback to inframarginal units once the target is reached), since they cannot improve upon 2PT under our information/risk setting.
Nocke and Thanassoulis (forthcoming) show that, in the presence of uncertainty, risk aversion may arise endogenously in supply chains when downstream firms face credit constraints in their future investments.
For example, Kolay et al. (2004) and Kolay, Shaffer, and Ordover (2004) focus on the relative profitability of these pricing schemes (for the upstream supplier) when they are used for optimal screening. In Section 5, we discuss how our work complements the previous work in understanding the supplier’s preferences over the different pricing schemes, when exclusion cannot be a motive.
In the EEA, when a dominant supplier restricts a downstream customer’s ability to resell its product to other businesses at the same level of the supply chain, but in other geographic markets, this action may be found incompatible with Article 101 and/or Article 102 of the EC Treaty.
For instance, consider a setting where only authorized dealers can sell the product.
Even if the implementation of market-share discounts requires costly monitoring of rival sales, there is a non-trivial range of costs for which the supplier might still strictly prefer using a market-share discount to using all-unit quantity discounts.
In a full information setting where the incumbent faces second period competition by entrants, Feess and Wohlschlegel (2010) show that all-unit discounts shift rents from the entrants. Greenlee, Reitman, and Sibley (2008) consider a monopolist that faces competition in a second market and shows that bundled loyalty discounts (that condition the rebate on the range of products purchased from the monopolist) have ambiguous welfare effects.
Another stream of literature analyses loyalty discounts as a source of endogenous switching costs in a dynamic, repeat-purchase context. See, for instance, Banerjee and Summers (1987) and Caminal and Matutes (1990).
In our setting, the retailers could be, for instance, relatively small convenience stores. It is plausible then that the manufacturer of a branded product offers the same contract to all retailers on a take it or leave it basis, rather than hold bilateral negotiations with each local retailer. So, if the supplier needs to deal with many local retailers, the transaction costs of negotiating individual contracts would justify his ability to make a take it or leave it offer. Finally, the assumption that the manufacturer makes a take it or leave it offer is not as restrictive as it may seem. For a relevant discussion, see footnote 9 in Inderst and Valletti (2009).
Given that the markets are identical apart from the resolution of the uncertainty, the expected outcome under different contracts can be captured by looking at the ex-ante situation for a given local market. Therefore, we suppress the multiplicity of markets for the rest of this article and refer to a single retailer while analysing the contracts.
We are very grateful to an anonymous referee for suggesting us to use this functional form to capture retailer risk aversion on a continuous scale.
See, for instance, Vives (2001).
The opposite is true when the demand is high, as the threshold in the optimal AU contract does not constrain the retailer’s choice in that case.
When the demand is low, under the AU contract, the retailer optimizes by choosing the quantity of the competitively supplied good corresponding to the threshold quantity of the manufacturer’s good and, although the sales are still distorted in favour of the competitively supplied good, the distortion is lower as
When the demand is high, for both contracts the retailer’s choices are governed by the first-order conditions and the distortion in the relative sales of the two goods is higher with the optimal AU contract
Total welfare is calculated as the difference between the gross utility of the consumers and the costs of production. Recall that the costs of production are normalized to zero in our model.
When acting on the share threshold, the retailer actually chooses the quantity of only one product (i.e. there is only one first-order condition in this case). The quantity of the substitute product is determined by the share requirement. Without loss of generality, we assume that the retailer chooses the quantity of the competitively supplied product ().
Nocke and Thanassoulis (forthcoming) show that, with an endogenously risk averse downstream firm, the optimal screening contract induces double marginalization and involves a fixed payment from the upstream firm to the downstream one. They argue that such slotting allowances are a risk sharing device. This interpretation is consistent with our results for the MS contract.
The contract they consider effectively requires the retailer to satisfy both a market-share target and a quantity target for achieving a certain price. This is different from the market-share contract we consider which only stipulates a market-share threshold.