Exclusionary Contracts

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Exclusionary Contracts
ABSTRACT The post-Chicago literature, notably
Aghion-Bolton (1987), has developed several
types of incentives for exclusionary contracts,
i.e. contracts through which an incumbent
supplier can profitably deter entry. This paper
extends the theory of exclusionary contracts and
illustrates the full range of the theory with an
analysis of a recent competition policy case.

• Ran Jing
• Ralph A. Winter
• Sauder School of Business
• UBC

CLEA MEETINGS 2007
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Issue
Introduction Synthesis Theory Nielsen
anticompetitive

• When is it profitable to write contracts that
  exclude rivals from a market?
• Two types of allegedly exclusionary contracts
• explicitly exclusionary
• exclusive dealing
• tying
• exclusionary by (alleged)effect
• long term contracts
• nonlinear pricing
• initial reaction skepticism

?
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Our Aim
Introduction Synthesis Theory Nielsen

• Synthesize theories exclusive dealing LTCs
• Extend set of theories
• Apply perspective to case
• Director of Investigation and Research v. DB
  Companies of Canada Ltd., CT-1994-01 (Canada),
  ("Nielsen")

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History of thought
Introduction Synthesis Theory Nielsen

• Traditional legal position
• If substantial share of a market foreclosed
• Chicago response
• Post-Chicago theories
• Aghion-Bolton I
• Aghion-Bolton II
• Raising Rivals Costs

long term contracts
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Synthesis Basic Structure
Introduction Synthesis Theory Nielsen

• Cost of entrants cE random
• Incumbent can offer ex ante contracts, or
  compete ex post
• ex ante (long term) contracts
• Price
• liquidated damage (penalty) to party for leaving
  contract
• Buyers identical

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Chicago
Introduction Synthesis Theory Nielsen
(A1) Perfect Competition in supply (A2)
Perfect competition among entrants
(same costs)

exclusive
Then maximize profits over ex ante contracts
(p,dB) subject to IR constraint yields
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Aghion-Bolton I
Introduction Synthesis Theory Nielsen
(A1) Perfect competition in supply (A2) One
potential entrant E 1 (A3) (say) 1
buyer (A4) buyer purchases 1 unit

Then maximize profits over ex ante buyer
contracts (p,dB) subject to IR constraint
Equivalent sell call option with option price
dB exercise price P - dB
yields
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Aghion-Bolton II
Introduction Synthesis Theory Nielsen
(A1) Free entry in supply (A2) Many entrants
fixed costs (A3) Many buyers

yields
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Raising Rivals Costs
Introduction Synthesis Theory Nielsen
(A1) N suppliers NOT free entry

yields
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Question
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• SUPPOSE
• perfect competition among entrants X
  Aghion-Bolton I
• number of buyers 1 X Aghion-Bolton
  II
• number of suppliers 1 X RRC
  theory
• THEN
• CAN THERE STILL BE INCENTIVE FOR LONG TERM
• EXCLUSIONARY CONTRACTS?

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YES
Introduction Synthesis Theory Nielsen

• Game
• I offers zero, one or both contracts (p,dB)
  (w,dS)
• entrants cost cE realized
• ex post -- competitive alternative available
  at cE.
• -- if B and S in contract(s), decide whether to
• breach, sharing surplus from breach in shares (?,
  1-?)

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Game Summary
Introduction Synthesis Theory Nielsen

• work out payoffs in each game, given cE, then
  average across cE
• for single LTC strategy, and for dual LTC
  strategy, must work out IR constraint.
• Payoffs to dual LTC strategy depend only on sum
  of dB dS
• But IR constraints depend upon each of dB and dS

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Profit from LT Contracts
Introduction Synthesis Theory Nielsen
p

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Summary
Introduction Synthesis Theory Nielsen

• Long term contracts profitable as means of
  extracting rents from excluded parties
• entrant ABI
• horizontal ABII
• vertical here
• But policy ?

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Nielsen
Introduction Synthesis Theory Nielsen

• Facts
• Market scanner-based information
• Upstream suppliers (chains) raw data
• Incumbent Nielsen
• Potential entrant (summer 1986) IRI
• Main Contracts
• with upstream suppliers 5-year exclusives

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Nielsen
Introduction Synthesis Theory Nielsen

• Why these contracts?
• Allowed monopoly
• But was this a horizontal combination of across
  substitutes?
• Spose upstream monopolists in each input
• Conventional theory does not pay to facilitate
  monopoly at another stage
• But essential fact inputs are information

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Nielsen
Introduction Synthesis Theory Nielsen

• Other Features of Case
• Nielsen and IRI competed in contracts
• Rents shifted upstream
• Contract offers sequential, not simultaneous
• Complex contracting dynamics
• Long term contracts struck with particular buyers
  downstream
• Which ones?
• Consistent with prediction
• Policy

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Nielsen
Introduction Synthesis Theory Nielsen

• Other Features of Case
• staggered contracts
• what if Nielsen had asked Bureau to allow
  most-favoured nation clauses?
• Did Tribunal ruling make any difference?
  Implicit contract theory.