Econ 106I (Galles) – Lecture 10 (
Telser
If you were a manufacturer, you would want a retailer to sell stuff at a lower price for a given wholesale price.
Increases quantity sold which would increase your total revenue
Why would a manufacturer want to have retailers sell at a higher price?
**Diagram**
This is called retail price maintenance – “Fair Trade” – Two names for the same concept
This requires monopoly power – resist the temptation to condemn this
Telser says that increasing prices may benefit consumers. Look at quantity, not price. Higher quantity means greater willingness to pay revealed.
What is the mechanism for this?
Example: What if the product must be demonstrated to be sold?
These demonstration services cost money. Whoever provides the demonstration must bear the cost and thus increase price. To prevent others from free-riding (and thus eliminating any benefit from demonstrating), the manufacturer must set a higher markup.
Why will the free rider try to sue the manufacturer? They can potentially get triple the damages if they have a dumb judge.
“Fair trade” – to sell my product, you must charge at least a certain amount. Low cost of enforcement.
If there is fair trade, it is in the retailers’ self-interest to compete the way the manufacturer wants them to (increase Q sold)
Alternative: Manufacturer can retail – eliminates free-rider problem. But what if manufacturer is not good at retailing?
Retail price maintenance allows specialization in retailing by the retailers and production by the manufacturers.
What if I offer $3 every time a retailer SAYS they are demonstrating?
This is difficult to monitor
What if I have two wholesale prices – one to the retailer who advertises, one to the advertiser who does not?
Arbitrage. Price discrimination is illegal. The demonstrating company can still shirk. Difficult to monitor.
Exclusive territories – creates opportunity for appropriable quasi-rents – gives the retailer market power.
If government misunderstands the mechanism, they might make this efficient mechanism illegal.
Connection to Alchian: search cost reduction argument. If I know prices are the same everywhere, I will not search (with respect to prices).
This could also be part of a cartel argument. What if the retailers colluded to increase markup without providing additional services?
Not in the interest of the manufacturers.
Second cartel argument (light bulb case) – What if there are no special services? Then the efficiency argument does not apply here.
What if manufacturer demands a lower retail price? You will see supplemental restrictions in this case
Rule of reason – think critically about motives before condemning certain behavior.
Supplemental restrictions (to prevent undercutting of cartel) include retail price floor, restriction to only one brand per store, accurate inventory accounting
Barrier to entry on the manufacturing side. License agreements, etc.
Another mechanism: Salesman commission. Under what circumstances will increasing commission lead to higher sales?
Wal-Mart – Not worth it here
Use car salesman
There is an efficient level of commissions
White motor case – Parts and service department wasn’t very profitable because there weren’t very many white motor trucks. Demanded that retailers provide parts and services to increase white motor sales. In exchange, offered exclusive territories. The scale of optimal promotion depends on scale of marketing problem.
If I don’t understand the problem, it is probably solving a problem efficiently.
Klein-Saft
Franchising – leasing reputation. Predictability is an important consideration for consumers.
Who captures benefits if I shirk as a franchisee by lowering costs? I do. Who pays the cost? The franchisor
What role does repeat business play?
There is a smaller problem if there is repeat business.
McDonald’s might own the franchises on a freeway, because they don’t have the incentive to deviate.
Chicken Delight – Forced exclusive territories that were far from freeway and forced home delivery to increase repeat business.
TBA problem (tires, batteries, and accessories)
Chevron versus Bob’s gas – Chevron has more to lose by shirking (does franchisee also have incentive not to shirk?)
Chevron controls quality by limiting variety of inventory
Chevron imposed price ceilings to prevent rip-offs
Restrict quality and price – solve rip-off problem.
Franchisor has to retain reputation, so they don’t rip off franchisees
This holds in times of growth. What about in times of decline?
(p. 345) Courts have said that there is a “per se” illegal agreement. To make me buy inputs from you exclusively, this might solve a problem (quality control), but courts rule against this.
Alternative to being exclusive supplier of inputs – standards requirements. But these introduce monitoring costs.
Courts recommend standards because they don’t understand the problem.
3 things need to be prove
1. Sufficient market power in tying good – always met because of recognizable brand name.
2. Not insignificant amount of commerce affected – this is always met because everything is significant
3. Two products exist – this is the only way to win
2 should not have been met. The market power the franchisor has is not in the relevant market.
The relevant market is between franchisor/franchisee BEFORE the franchisee enters the relationship.
Source tie versus rent-a-name tie is irrelevant according to Klein-Saft
Chicken Delight – did not monitor quality of chicken. They collected more money from the more profitable franchises by monitoring sales of paper products
In addition, there was a lot of repeat business
This is how they solved the quality issues
They picked the story that is not necessarily true, but is more likely to convince a jury.
Profit premium stream argument (Klein-Crawford-Alchian) applies here.
Free riding problem in Telser – Evil retailer is free riding on others
Free riding problem in Klein-Saft – Evil franchisee is free riding
No consumers win from the free-riding problem in Klein-Saft
Someone wins from the free-riding problem in Telser. (The consumers who experience the demonstration and then buy elsewhere at a lower price.)