09/10/08 Bundling and Competition for Slots 1

Bundling and Competition for Slots

Doh-Shin Jeon (UPF, TSE)

Domenico Menicucci (Universita di Firenze)

Seminar at Université de Paris X, October 9, 2008

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Motivation 1: Competition among portfolios

Firms sell portfolios of distinct products and buyers want to constitute their own portfolios

- Publishers of academic journals/ Libraries

- Movie studios/ Movie theaters or TV broadcasting companies

- Manufacturers (Nestle, Danone etc)/ supermarkets

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Motivation II: Slot (or shelf space) constraint

Slotting arrangements, the payment by manufacturers for retail shelf space, have become increasingly important

Recent antitrust litigation: - R.J. Reynolds Tobacco Co. v. Philip Morris,

Inc. (2002)- American Booksellers Ass'n, Inc. v. Barnes &

Noble (2001)- FTC v. H.J. Heinz Co.(2000) Federal Trade Commission studies: FTC

Report (2001) and FTC Study (2003)

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Questions

When firms compete to sell portfolios of distinct products to a buyer having a slot constraint,

1. How bundling affects competition for slots and social welfare?

2. Implications on horizontal merger?

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Answer to question 1

Without bundling, equilibrium often does not exist

With bundling,

1. Efficient equilibrium always exists

2. Without slotting contracts, all equilibria are efficient for low costs of production

3. With slotting contracts, inefficient equilibria exist even for zero cost of production

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Société des Caves de Roquefort

Conseil de la Concurrence (2004) fined Société des Caves de Roquefort for using selectivity or exclusivity contracts with supermarket chains.

Its market share in the Roquefort cheese market was 70%

But, through the contracts, it could occupy eight among all nine brands that Carrefour, a supermarket chain, carried.

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Procter & Gamble

“P&G has big plans for the shelves of tiny stores in emgering nations” (Wall Street Journal, July 17, 2007)

‘Golden Store’ arrangement: to be considered a golden store, retailers must agree to carry 40 or so P&G items – displayed together

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Slots in Movie theator

Cahiers du Cinema: Nos 12 Propositions pour le cinema (Avril, 2007)

“5. Limiter le nombre de copies par film. La sortie de certains films sur 600, 800 ou 1000 copies rend illusoire toute politique culturelle efficace. En saturant les écrans, …, elle impose aux autres films un accès miniscule aux écrans restants…”

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Block booking

Two supreme court decisions: per se illegal

- U.S, v. Paramount Pictures (1948)- U.S. v. Loew’s (1962)- Reaffirmed in court of appeal: MCA

Television Ltd. V. Public Interest Corp. (1999)

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Leverage Theory and Block Booking

“A distributor cannot use the market power granted by the copyright in a “desirable” film to force exhibitors to license a second “undesirable” film”

“Block booking made it difficult for the independents to get their own movies into theaters”

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Roadmap

1. Chicago school criticism of leverage theory

2. Illustration of the key intuition: example

3. Main results

4. Implications on horizontal merger

5. Literature review

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Chicago School Criticism

Two firms (A,B) and two products (1,2)A is the monopolist of product 1A and B compete in product 2Zero cost of productionA single buyer with unit demand for each

product.Buyer’s utility: uA

1 >0, uA2 >0, uB

2 >0Assume uA

1 + uA2 > uB

2

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Chicago School Criticism

Without bundling: - A sells product 2 iff uA

2 uB2

- A’s profit: uA1 +max{0, uA

2 - uB2 }

With bundling: - A always sells both products- A’s profit: uA

1 + uA2 – uB

2

A has no incentive to use bundling for the purpose of monopolizing product 2

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Our contribution

Chicago Criticism provides a weak argument for laissez-faire

- Firms have no strict incentive to practice bundling

- Letting firms practice bundling never strictly increases social welfare since outcome is always efficient without bundling

- Prohibiting bundling has no social cost!!! We provide a strong argument for laissez-faire

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Illustration with a simple example

Two firms (A, B)One buyer with two slotsA has two products with (uA

1,uA2)=(4,2)

B has one product with uB1 =3

Cost of production is zeroIndependent valuesEfficiency requires A’s best product and

B’s product to occupy the slots

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No equilibrium without bundling

Simultaneous pricing gameTie-breaking: when D is indifferent, D

maximizes the sum of the gross valuesNo equilibrium in which B does not sell

its product

- B can deviate by undercutting A’s second product’s price

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No equilibrium without bundling

No equilibrium in which B sells its products

- Conditional on that B sells its product, the best A can do is to charge pA

1=4, pA2

≥2 - Then, B’s best response is to charge

pB1=3.

- Then, A has an incentive to undercut B by charging pA

1=4, pA2 =2-

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Bundling

Consider pure bundling: A sells a bundle of both products

In the equilibrium, PA = 4 and PB = 1. Both bundles are purchased and hence the buyer allocates the slots efficiently.

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Intuition for efficiency

Bundling gets rid of internal competition and makes external competition efficient

Start from pA1=4, pA

2 =, Without bundling, if A charges pA

1=4, pA2 =0,

there is cannibalization. With bundling, if A includes the second

product into the bundle and charges PA=4, it makes the bundle (weakly) more attractive: adding a product into a bundle never hurts the seller

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Strong argument for laissez-faire

Outcome of competition without bundling is not efficient but outcome with bundling is efficient

Firms in general have an incentive to practice bundling to get rid of cannibalization

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Model

There are n firms Each firm i has ni number of products One buyer with k number of slots Products of independent values cost of production: c ≥ 0 ui

j : Buyer’s gross profit from firm i’s j-th best product ui

1 ≥ui2 ≥… ≥ui

ni ≥0 W.l.o.g, ni ≥ k uj: D’s gross profit from the j-th best product among all

products

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Contracts

Given a bundle of m products of firm i (Mixed) Bundling (Pi,pi1 ,pi2,…,pim)

Pure bundling: bundling with pi1 =pi2…=pim=0

Slotting contracts: pure bundling plus the obligation to make m slots occupied by the m products

Menu of pure bundles:

in

mii mPmB 1)(),(

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A general result: for any c

Prop 1: An efficient equilibrium always exists Each firm offers a bundle of all its products and

charges pi1 =pi2…=pini=c (i.e. rents its technology at the cost)

Remark: Deviation with pure bundling or slotting contracts is not profitable

ii

iii

U

cUckUP

generating products of# theis # where

#

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Without slotting contracts: Uniqueness

For c small (i.e. c< uk - uk+1)- Prop 2: all equilibria are efficient, regardless of the level of

industry concentration For c> uk - uk+1,- Pure bundling can generate inefficient equilibria- Prop 3: Without pricing below cost (i.e. pij≥c for all i and j), all

equilibria are efficient and each firm’s profit is uniquely determined

- Lemma 1: Firm i can always find a best response among the tariffs satisfying pij=c for all j

- Remark: In the practice of competition policy in Europe and U.S. regarding predation, the prices set by a dominant firm are presumed abusive if they are below costs.

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Slotting contracts

Suppose that aIl firms use slotting contracts Lemma 2: If each firm offers a single bundle,

there is no interior equilibrium in which each firm sells at least a product.

Prop 4: If firms compete with menu of bundles, there exists an efficient equilibrium.

Prop 5: In the case of digital good, if we consider a non-decreasing price schedule: Pi(1)≤ Pi(2) ≤ …, all equilibria are efficient

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Equilibrium menu when c=0

1**

12**

1*

,0max)1()(

....

,0max)1()2(

,0max)1(

ikiii

kiiii

kiii

uukPkP

uuPP

uuP

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Inefficient equilibrium under slotting contracts

Two firms, three products, three slots

Efficiency requires firm A to sell its two best products and firm B to sell its best product

Inefficient equilibrium exists: Bertrand competition between two pure bundles leads to PA =7 and PB=0

1,7,9,,

6,8,10,,321

321

BBB

AAA

uuu

uuu

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Equilibrium selection

Prop: In the case of duopoly, when both firms use slotting contracts, all other equilibria are Pareto dominated by the efficient equilibrium

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Horizontal merger

Consider the merger of any two firms Prop 6:

(i) The merger affects neither social welfare nor any third upstream firm’s profit(ii) The merger increases the merging firms’ profits and decreases the downstream firm’s profit.

Intuition: A merger softens competition from the best alternative portfolio

Remark: O’Brien-Shaffer (2005) obtains the same result without slot constraint in a bargaining setting

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Economies of scale

Products of identical values can be sold at different prices

Adding a product of another firm into a firm’s portfolio (at least weakly) increases its profit even though the product is not sold

A product in a larger porfolio receives better protection from competition from other products

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Endogenous merger and increasing concentration

Consider a second-price auction of a product of value u owned by a firm

Prop 7:

Corollary: If there exists a firm (say firm 1) with

then, the firm wins the auction.

otherwise ,0

,max if , ,max 11

i

ki

kii

b

ucuucub

jiuu ji

j , 1

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Literatture review: bundling

Most of the papers on bundling study bundling of two goods in the context of second-degree price discrimination : Schmalensee (1984), McAfee et al (1989), Whinston (1990), Salinger (1995), Armstrong (1996), and Nalebuff (2004)

Two issues: rent extraction of a monopolist or entry deterrence

Internet and bundling a large number of (information) good: Armstrong (1999) and Bakos and Brynjolfsson (1999, 2000)

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Comparison with Jeon-Menicucci (JEEA,2006)

JEEA Setting: the same Budget constraint Bundling always

reduces social welfare

This paper Setting: the same Slot constraint Bundling increases

social welfare

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Literature review: common agency

Berheim-Whinston (1985, 1998) and O’Brien-Schaffer (1997): competition in non-linear tariff between two single-product firms leads to joint profit maximization

O’Brien-Schaffer (2005): Similar result with n firm bargaining

Our novelty: - competition among portfolios under slot constraint- Digital vs. physical good- various contracting arrangements

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Future work

Extension:

- allow for substitutes

- variable quantity

- then “exclusive dealing” is a special case with n=2, ni=1 and k=2.