Competition and Cooperation in the Market for Exclusionary Rights

Abstract

Salop and David Scheffman (1983) show that firms profitably can gain market power by conduct that raises their competitors' costs. Raising rivals' costs is a more credible route to market power than is predatory pricing because it is not necessary to cause the rivals to exit, no deep pocket is required, and the additional profits are gained immediately. That paper argues that vertical restraints and contracts with input suppliers can be fertile ground for raising competitors' costs. By contracting with one or more suppliers to exclude rivals, either by dealing with them on discriminatory terms or refusing to deal with them altogether, a firm sometimes can increase its rivals' costs. As a result, it can sometimes gain the power to raise price in the market in which it sells output. This type of contract often can be characterized as the purchase of an exclusionary right from the input suppliers. That is, in addition to the purchase of inputs, the predator also purchases the right to exclude (some of) its rivals from access to the suppliers' inputs. Exclusionary rights contracts can exist in a variety of forms. At one extreme are agreements that involve only exclusionary rights; no inputs are exchanged at all. For example, it was reported in Alcoa that at one time Alcoa purchased exclusionary covenants from power companies from which it did not purchase electricity. The contracts involved only the utilities' promises not to sell electricity to other aluminum companies. Such naked exclusionary rights contracts are unusual, of course. Most exclusionary rights are bundled with the sale of inputs. For example, Stroh Beer has alleged that the two major brewers purchase not only advertising time on network sports programs, but also the right to exclude remaining brewers from advertising on those same programs, even though the networks have other advertising time available. It might be argued that such exclusionary conduct would always fail for two reasons: the excluded rivals would have available effective counterstrategies to prevent their own exclusion; and input suppliers would have no incentives to reduce their sales by excluding some customers. These criticisms imply that raising rivals' costs by contracting with suppliers would not be credible. It surely is not true that exclusionary strategies to restrict rivals' input purchases will always succeed in raising their costs. For example, where rivals easily can substitute to other equally cost-effective inputs, or where entry into the production of inputs is so easy that the excluded rivals can efficiently produce the input themselves, then cost-raising strategies will fail. Moreover, where competition in the output market would be sufficient to maintain low prices despite the exit or increased costs of the excluded competitors, then no profit-maximizing firm would spend any resources trying to exclude those rivals. These conditions are discussed in detail in our earlier paper (1985). tDiscussants: Ronald H. Coase, University of Chicago; Gregory K. Down, Yale University; David Sappington, Bell Communications Research and University of Pennsylvania.

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