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Wholesale Bargaining: Models and Antitrust Implications

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Hart and Tirole (1990) O'Brien and Shaffer (1992) McAfee and Schwartz (1994) ... Grossman-Hart-Moore. MacDonald and Ryall (2004) Brandenberger and Stuart (2006) ... – PowerPoint PPT presentation

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Title: Wholesale Bargaining: Models and Antitrust Implications


1
Wholesale Bargaining Models and Antitrust
Implications
  • Joshua Gans
  • Melbourne Business School
  • University of Melbourne

2
Background Papers
  • Joint work with Catherine de Fontenay
  • RAND Journal of Economics, 2005
  • Review of Network Economics, 2005
  • IJIO, 2004
  • Bilateral Bargaining with Externalities
  • Applications
  • Concentration Measures and Vertical Market
    Structure (JLE forthcoming)
  • Markets for Competitive Advantage (w/ Michael
    Ryall)
  • Network Bargaining (Martin Byford)

3
Wholesale Markets
  • Posted prices
  • Spengler (JPE) double marginalisation
  • Salinger (QJE) successive Cournot oligopoly
  • Take it or leave it offers
  • Hart and Tirole (1990)
  • OBrien and Shaffer (1992)
  • McAfee and Schwartz (1994)
  • Segal (1999)
  • Marx and Shaffer (2004)
  • Bargaining
  • Inderst and Wey (2003)
  • OBrien and Shaffer (2004)
  • Segal and Whinston (2001)
  • Stole and Zwiebel (1996)
  • Grossman-Hart-Moore
  • MacDonald and Ryall (2004)
  • Brandenberger and Stuart (2006)

4
Antitrust Issues Traditional Views
  • How do we analyse competition between sellers
    into a wholesale market?
  • Same as any horizontal market
  • Versus countervailing power from buyers
  • How do we analyse vertical restrictions?
  • Perfect efficient contracting vertical practices
    only chosen for efficiency reasons
  • Versus firms with market power who can use
    practices to extract rents

5
New Results
  • Changes in competition (e.g., concentration) in
    upstream markets have a different impact on final
    consumers than changes in downstream markets
  • Vertical practices can have anti-competitive
    effects and result in a redistribution of rents
  • Can use quantitative bargaining models to analyse
    trade-offs

6
Outline
  • Our Bargaining Model and Result
  • Treatment of Upstream Competition
  • Analysis of Vertical Integration
  • Future Directions

7
The Research Goal for Strategy
Surplus Generated
  • Environmental Characteristics
  • Consumer demand
  • Resource availability
  • Production technology
  • Bargaining power

Payoffs to owners of factors of production
Surplus Division
Given environmental characteristics, what are the
expected payoffs to factor owners? That is, what
determines appropriability.
8
Cooperative Bargaining Theory
  • The Benefits
  • Relates environmental characteristics to surplus
    division
  • Easy to compute
  • E.g., Myerson-Shapley value is weighted sum of
    coalitional values
  • The Problems
  • Presumption that coalitions operate to maximise
    surplus
  • Requires observable and verifiable actions
  • Coalitional externalities are usually assumed
    away
  • If considered, impact on division only (Myerson)

9
Non-Cooperative Bargaining Theory
  • Benefit Robust predictions in the bilateral case
  • Nash bargaining
  • Rubinstein and Binmore-Rubinstein-Wolinsky
  • Problem Bilateral case in isolation cannot deal
    with
  • externalities
  • coalitional formation

D1
U1
10
We need a theory that can deal with this
  • Competitive Externalities
  • Ds and Us may be competing firms
  • Cant negotiate
  • Bilateral Contracts
  • Ds and Us cannot necessarily observe supply terms
    of others
  • Connectedness does not necessarily imply surplus
    maximisation

D1
D2
UA
UB
while being tractable and intuitive.
11
Our Approach
  • Bilaterality
  • Assumes that there are no actions that can be
    observed beyond a negotiating pair
  • Potential for inefficient outcomes
  • Non-cooperative bargaining
  • Does not presume surplus maximisation
  • Looks for an equilibrium set of agreements

12
Our Results
  • In a non-cooperative model of a sequence of
    bilateral negotiations
  • There exists a Perfect Bayesian Equilibrium
    whereby
  • Coalitional surplus is generated by a Nash
    equilibrium outcome in pairwise surplus
    maximisation
  • Division is based on the weighted sum of
    coalitional surpluses
  • We produce a cooperative division of a
    non-cooperative surplus
  • Strict generalisation of cooperative bargaining
    solutions
  • Collapses to known values as externalities are
    removed
  • Non-cooperative justification for cooperative
    outcomes

13
Some Notation
  • Actions
  • qij is the input quantity purchased by Di from Uj
  • tij is the transfer from Di to Uj
  • (A1) Can only observe actions and transfers you
    are a party to (e.g., UB and D2 cannot observe
    q11 or t11)
  • Primitive Payoffs
  • Di p(qiAqiB, q-iAq-iB)ti1ti2
  • Uj t1j t2j c(q1jq2j)
  • Usual concavity assumptions on p(.) and c(.)

D1
D2
UA
UB
14
Network State
  • Network
  • Bilateral links form a graph of relationships
    denoted by K
  • Initial state K (1A,1B,2A,2B)
  • If a pair suffer a breakdown (e.g., D1 and UA),
    the new network is created
  • New state K (1B,2A,2B)
  • (A2) The network state (K) is publicly observed

15
Possible Contracts
  • Bilaterality
  • As terms of other pairs are unobserved by at
    least one member of a pair, supply terms cannot
    be made contingent upon other supply contract
    terms
  • Network Observability
  • As the network state is publicly observed supply
    terms can be made contingent on the network state
  • Example
  • q11(1A,1B,2A,2B) 3 and t11(1A,1B,2A,2B) 2 and
    q11(1A, 2A,2B) 4 and t11(1A, 2A,2B) 5 and
    so on.

16
Extensive Form
  • Fix an order of pairs (in this case 4)
  • Precise order will not matter for equilibrium we
    focus on
  • Each pair negotiates in turn
  • Randomly select Di or Uj
  • That agent, say Di, makes an offer qij(K),
    tij(K) for all possible K including Di and Uj.
  • If Uj accepts, the offer is fixed and move to
    next pair
  • If Uj rejects,
  • With probability, 1-s, negotiations end and
    bargaining recommences over the new network K
    ij.
  • Otherwise negotiations continue with Uj making an
    offer to Di.
  • Binmore-Rubinstein-Wolinsky bilateral game
    embedded in a sequence of interrelated
    negotiations
  • Examine outcomes as s goes to 1.

17
Beliefs
  • Game of incomplete information
  • Need to impose some structure on out of
    equilibrium beliefs
  • Issue in vertical contracting (McAfee and
    Schwartz Segal) in that one party knows what
    contracts have been signed with others and
    offer/acceptance choices may signal those
    outcomes
  • Simple approach impose passive beliefs
  • Let be the set of
    equilibrium agreements
  • When i receives an offer from j of
    or
  • i does not revise its beliefs about any other
    outcome of the game

18
Equilibrium Outcomes Actions
  • Bilateral Efficiency
  • A set of actions satisfied bilateral efficiency
    if for all ij in K,
  • Suppose that all agents hold passive beliefs.
    Then, as s approaches 1, in any Perfect Bayesian
    equilibrium, each qij(K) is bilaterally efficient
    (given K).

19
Equilibrium Outcomes Actions
  • Suppose that all agents hold passive beliefs.
    Then, as s approaches 1, in any Perfect Bayesian
    equilibrium, each qij(K) is bilaterally efficient
    (given K).
  • Intuition
  • Negotiation order 1A,1B,2A,2B and suppose that
    1A and 1B have agreed to the equilibrium actions
  • If 2A agree to the equilibrium action, 2B
    negotiate and as this is the last negotiation, it
    is equivalent to a BRW case so they choose the
    bilaterally efficient outcome
  • If 2A agree to something else, D2 will know this
    but UB wont
  • UB will base offers and acceptances on assumption
    that 2A have agreed to the equilibrium outcome
    (given passive beliefs)
  • D2 will base offers and acceptances on the actual
    2A agreement. Indeed, D2 will be able to offer
    (and have accepted) something different to the
    equilibrium outcome
  • Given this, will 2A agree to something else?
  • D2 will anticipate the changed outcome in
    negotiations with UB
  • Under passive beliefs, UA will not anticipate
    this changed outcome (so its offers dont change)
  • D2 will make an offer based on
  • By the envelope theorem on q2B, this involves a
    bilaterally efficient choice of q2A.

20
Equilibrium Outcomes Payoffs
  • Result As s approaches 1, there exists a perfect
    Bayesian outcome where agents receive
  • This is each agents Myerson-Shapley value over
    the bilaterally efficient surplus in each
    network.

21
Remarks
  • Stole and Zwiebel adopt a similar approach in
    proving their non-cooperative game yields a
    Shapley value
  • Make mistake do not specify belief structure
  • Our most general statement shows that the
    solution concept is a graph-restricted Myerson
    value in partition function space.
  • The symmetry in the buyer-seller network case
    masks some additional difficulties in the general
    case
  • There is some indeterminacy in the complete graph
    case
  • The cooperative game solution concept has never
    been stated before
  • Nor has it been related to component balance and
    fair allocation
  • So our proof does cooperative game theory before
    getting to the steps before

22
Ultimate Solution
  • where
  • N is the set of agents
  • P is a partition over the set of agents with
    cardinality p
  • PN is the set of all partitions of N
  • L is the initial network (i.e., initial set of
    bilateral links)
  • LP is the initial network with links severed
    between partitions defined by P.

23
Additional Results
  • (No component externalities) Suppose that
    primitive payoffs are independent of actions
    taken by agents not linked the agent
  • Obtain the Myerson value over a bilaterally
    efficient surplus.
  • (No non-pecuniary externalities) Suppose that the
    primitive payoffs are independent of the actions
    the agent cannot observe
  • Obtain the Myerson value.
  • If agreements are non-binding and subject to
    renegotiation, the results hold.

24
Computability
m buyers
Bilaterally efficient surplus with m-s buyers
supplied by both suppliers
S1
S2
Bilaterally efficient surplus if s buyers are
supplied only by S1 and h are supplied only by S2
25
Upstream Competition
  • Why upstream competition should be treated
    differently when there is wholesale bargaining?

26
2 x 2 Structure (NI)
27
Model Structure Notation
  • 2 upstream 2 downstream assets each with an
    associated manager (necessary for the asset to be
    productive) integration changes ownership but
    not need to use manager
  • Uj can produce input quantities, q1j q2j to D1
    and D2 at cost, cj(q1j, q2j) quasi-convex
  • D1 earns (gross) profits of p1(q1A,q1Bq2A,q2B)
    concave in (q1A,q1B) and non-increasing in
    (q2A,q2B).
  • Industry profit outcomes

28
Upstream Merger
29
Incentives to Merge
  • Upstream firms jointly gain
  • One third of the profits from a UB Monopoly
  • Intuition the possibility that a breakdown could
    generate this was used by downstream firms as
    leverage on the other upstream firm
  • Downstream firms jointly lose this
  • Face higher transfers

30
Impact on Efficiency
  • Bilateral negotiations for upstream supply under
    upstream competition
  • Bilateral negotiations for upstream supply under
    upstream monopoly
  • No difference in outcomes so no impact on
    efficiency

31
Upstream Competition
  • Changes to upstream competition have a different
    impact to changes in downstream competition
  • Fragmentation amongst downstream firms drives
    impact on consumers, input and output choices. It
    constrains upstream market power.
  • Extreme permit upstream mergers when there is no
    vertical integration
  • Leads to additional upstream investment (maybe
    over-investment)
  • May lead to reduced downstream entry

32
Vertical Integration
  • What is the competitive impact of vertical
    integration?

33
Effect of Integration
BI
FI
34
Will D1 and UA profit from VI?
UC
UM
FI
BI
35
Comparisons
  • FI versus BI
  • UC versus UM
  • As downstream products become more
    differentiated, strategic VI is more likely under
    upstream competition than upstream monopoly

36
Impact on Efficiency
  • Bilateral negotiations for upstream supply under
    NI
  • Bilateral negotiations for upstream supply under
    VI
  • Incentive to raise rivals costs

37
VI and Foreclosure
  • Upstream competition
  • With homogenous inputs (and some symmetry), VI
    does not change efficiency
  • Upstream monopoly
  • VI leads to industry profit maximisation (with
    symmetry and substitutability) D2 is not
    supplied any inputs
  • Under FI, D2 still receives a payoff of
  • Technical foreclosure but downstream firm still
    valuable in disciplining internal negotiations

38
An Outsourcing Issue
  • Outsourcing (make vs buy) decision
  • Typically assumes new function or no sunk
    assets in the industry
  • Major outsourcing decisions typically involve
    existing assets that must be divested or scrapped
  • Dilemma
  • If outsource to existing firm, vulnerable to lack
    of upstream competition in the future (lack of
    long-term contracts).
  • If create new independent supplier, assets
    divested may not be worth as much.
  • Examples GE to Matsushita vs Samsung Motorola
    to BenQ.

39
Outsourcing Dilemma
UA
UB
UA-UB
or
?
D1
D2
D1
D2
Create UA or sell assets to UB? Integration
implies common ownership of assets Assume that D1
and D2 do not compete and fixed gain from
outsourcing, D
40
Results
  • D1 chooses to outsource to UB over an independent
    firm if
  • Established outsourcing reduces D1s profits by
  • But increases total upstream profits (UA and UB)
    by
  • Always occurs
  • Choose the option that harms D2 the most that is
    where the rents are coming from

41
Summary
  • Outsourcing and upstream competition
  • Standard view more likely to outsource when
    upstream markets are competitive
  • Here outsourcing incentives stronger if can
    preserve or establish upstream market power
  • Outsourcing and competitive advantage
  • Standard view outsourcing gives comp adv
  • Here outsourcing more desirable if harms other
    downstream firms but no comp adv as supply on
    equal terms

42
Quantitative Evaluation
  • How can mergers impacting on vertical market
    structure be evaluated?

43
Wholesale Bargaining
  • N firms indexed by i
  • Each may operate in an upstream and/or downstream
    segment
  • si downstream share
  • si upstream share
  • Perfect substitutes (downstream)
  • Market demand P(Q)
  • Costs upstream (Ci(.)), downstream (ci(.))

44
Lerner Index for Vertical Chain
  • Negotiations between i and j

45
Vertical HHI
  • The average Lerner index is
  • If there is a preference for internal supply,

46
Properties
  • Ranges between 0 (perfect competition) and 10,000
    (downstream monopoly)
  • Collapses to HHI (Downstream) when all downstream
    firms are net buyers of inputs or non-integrated
  • If there is integration then VHHI gt HHI
  • Upstream concentration not relevant
  • Non-integrated upstream mergers do not change
    VHHI
  • Only look upstream if merger involves a net
    supplier

47
Some Examples
  • Example 1
  • 4 equal sized upstream firms and 10 equal sized
    downstream ones
  • Up HHI 2500 Down-HHI 1000 VHHI
  • Vertical merger leaves HHIs unchanged (no
    concern) but raises VHHI to 1150 (potential
    concern)
  • Example 2
  • 8 downstream firms with 10 share and a 9th with
    20 share
  • If vertical merger involves large firm then HHI
    does not change but VHHI goes from 1300 to 1400
    (no concern) despite higher concentration.

48
Approach 2 Successive Oligopoly
  • Firms post unit prices in wholesale market
  • With linear demand and costs (and homogenous
    inputs)
  • Like bilateral bargaining but with additional
    distortions (that can be removed by vertical
    integration)

49
Application Exxon-Mobil in California
50
Concentration Measures
51
Future Directions
  • Other Vertical Practices
  • Exclusive dealing
  • Negotiations over linear prices
  • Quantitative Analysis
  • Construct simulation model of bargaining
  • Empirical tests of vertical market structure
    concentration measures and pricing
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