The presence of a hub-and-spoke conspiracy legally depends on whether a horizontal agreement exists among the spokes, commonly stated in terms of whether there is evidence of a “rim” that connects the spokes. This article shows that the circumstantial evidence a court may use to infer such an agreement is substantially more limited than the circumstantial parallel behavior evidence commonly used in a standard horizontal conspiracy case. One must also explicitly consider the vertical relationship between the hub and spokes and exclude the possibility that the parallel spoke behavior involves merely a series of separate vertical agreements accepted by each spoke in its individual interests. The analysis clarifies that the key economic condition that must be focused on is the hub’s vertical contract enforcement sanction and hence its ability to unilaterally enforce its vertical contract demands. Determining whether a fact pattern should be considered circumstantial evidence of a horizontal agreement or merely a series of purely vertical agreements involves analysis of the economic costs and gains of individual spoke non-compliance and the speed of simultaneous spoke acceptance of hub contract terms. These factors are examined in a number of recent hub-and-spoke cases, as well as the classic case of Interstate Circuit.

Author(s): Barnett, Jonathan; Baye, Michael R; Cooper, James C; Crane, Daniel A; Elzinga, Kenneth G; Epstein, Richard; Garza, Deborah; Hazlett, Thomas W; Hurwitz, Justin Gus; Klein, Benjamin; Klick, Jonathan; Lambert, Thomas A; Lipsky, Tad; Manne, Geoffrey A; Masten, Scott E; Ohlhausen, Maureen; Rill, James; Rybnicek, Jan; Smith, Vernon L; Teece, David; Willig, Robert; Wright, Joshua D; Yun, John M

This paper clarifies the relation between per se hub-and-spoke and vertical rule of reason antitrust analysis, the tension between which is illustrated with a detailed examination of the Apple e-books case.

Apple’s economic role in the Publisher conspiracy to increase Amazon’s below cost pricing of e-books is examined in a hub-and-spoke conspiracy framework. The Publishers conspired because of their concern that Amazon’s low prices would adversely affect physical book demand and prices and also create an Amazon retail monopoly under which Amazon would negotiate substantially lower wholesale e-book prices. The Publisher conspiracy successfully moved Amazon to an agency relationship and gained control over e-book retail pricing. This was accomplished with joint Publisher threats of Amazon to window (delay) the release of new e-book titles, which imposed a significant potential cost on Amazon in the face of Apple's scheduled entry with access to all new release titles without delay. It is demonstrated that Apple economically facilitated the Publisher conspiracy solely through its entry, not through any of its iBookstore contract terms. Specifically, contrary to the court, the MFN and maximum price terms in the Apple contracts had no effect on facilitating the Publisher conspiracy. In fact, if Apple had entered without these contract terms, e-book prices would have been substantially higher. Apple's contracts therefore should not have been evaluated under a per se standard.

A recent wave of large vertical mergers presents a challenge to established theories of vertical integration. The large mergers that have occurred in the pharmaceutical industry between drug manufacturers and companies that manage drug insurance benefits (such as Merck's acquisition of Medco) and in the entertainment industry between program suppliers and network distributors (such as Disney's acquisition of Capital Cities/ABC) do not seem to fit traditional economic theories of vertical integration. The proximate causes for these mergers are fairly obvious. The entertainment mergers have been motivated by regulatory changes that permit TV networks to own the product they distribute, and the drug industry mergers have been motivated by the demonstrated ability of drug insurance managers to influence the sales share of different patented drugs within a therapeutic category. However, it is not obvious why these changes in the market environment led to vertical integration. To illuminate the economic motivation for these recent vertical mergers, we present an analysis of vertical integration that combines and extends our work on self-enforcing contracts (Klein and Murphy, 1988; Klein, 1996) with earlier work on vertical integration to avoid holdups (Klein et al., 1978). In what follows we first show that competitive, nonfree-riding distributors often face a distorted incentive to supply the promotional services desired by manufacturers. We then explain why the usual contractual solution to this distributor "malincentive" problem is likely to combine court enforcement and self-enforcement mechanisms. Finally, we outline how vertical integration may facilitate such a self-enforcing contractual arrangement.

7 Assessing resale price maintenance after Leegin Benjamin Klein* Antitrust evaluation of resale price maintenance under the rule of reason standard adopted in Leegin1 requires economic analysis of the likely anticompetitive effects and procompeti...

The government’s challenge to Standard Oil’s monopoly of refining and the resulting court-ordered break up of Standard Oil one hundred years ago, was motivated to a large extent by the now discredited idea of protecting competitors rather than preserving competition. Consistent with a principal concern of the framers of the Sherman Act that large corporations often received discriminatory discounts which placed small companies at an unfair disadvantage, the government focused its case on Standard Oil’s use of its dominant position to obtain preferential railroad rebates that forced rival refiners to either agree to be acquired by Standard Oil or to go out of business.

Resale price maintenance need not be economically justified by the prevention of free-riding. Consistent with business realities, point-of-sale retailer promotional efforts often have a significant effect on consumer demand for a manufacturer’s products; and manufacturers often use resale price maintenance as an efficient way to purchase these promotional services from retailers. Even when there is no retailer free-riding, a retailer that discounts may reduce the compensation received by other retailers for promoting the manufacturer’s products, leading other retailers to discontinue distribution or reduce the promotional efforts they devote to the sale of the manufacturer’s products. The resulting reduction in demand for the manufacturer’s products provides a procompetitive rationale for the prevention of retailer price discounting. This broadly applicable procompetitive motivation for resale price maintenance has important implications for antitrust analysis, whether the legal standard is rule of reason or per se liability.

Economic theories of the firm are categorized into two types of theories – those that emphasize the role of the firm in mitigating holdup problems by firm ownership of residual control rights and those that emphasize the role of the firm in mitigating incentive problems by firm ownership of residual profit rights. The economic definition of the firm that corresponds most closely with legal and common usage focuses on the ownership of residual control rights achieved through integration. This economic definition of the firm is fully consistent with the legal principles set forth in Copperweld but is inconsistent with the “unity of interests” criterion sometimes used in antitrust law.

Manufacturer competition for retail distribution is shown to often include partially exclusive contracts when competitive retailers have the ability to shift sales by loyal customers to a chosen manufacturer. Since each manufacturer knows its sales will increase substantially at the expense of rival brands if selected for partial exclusivity by the retailer, manufacturers will reduce their wholesale prices in the attempt to be selected. Inter-retailer competition will then largely pass the lower wholesale prices on to consumers in lower retail prices. Retailers can be thought of as acting as agents for their loyal consumers, trading off reduced product variety for price reductions preferred by their consumers as a group. The economic analysis provides a procompetitive justification for restricted distribution arrangements in the supermarket industry that have been the subject of antitrust litigation, and can be used to explain restricted distribution arrangements in the economy more generally.

Goldberg unconvincingly claims that the General Motors (GM)–Fisher Body contract was in fact legally unenforceable. But even if Goldberg's contract law conclusion were correct, it is economically irrelevant. It is clear from the actions of Fisher and GM and from the testimonial and other contemporaneous evidence that both transactors considered the contract legally binding and behaved accordingly. Therefore, proper economic analysis of the Fisher–GM case should continue to assume contract enforceability, and the economic determinants of organizational structure illustrated by the case remain fully valid.

This article presents an expanded economic analysis of the potential procompetitive purposes served by exclusive dealing. Using examples taken from important antitrust cases, exclusive dealing is shown to be an efficient element in the arrangements manufacturers adopt with their dealers to induce dealers to supply increased promotion. We describe two common circumstances where dealers have an incentive not to provide the increased promotion for which the manufacturer has compensated them. First of all, dealers may use the increased promotional efforts that have been purchased by the manufacturer to switch consumers to other products on which they can earn greater profit; and secondly, dealers may fail to supply the increased promotion paid for by the manufacturer. Exclusive dealing is shown to mitigate both of these types of dealer free-riding, which are distinct from the type of free-riding examined in the standard economic and antitrust analysis of exclusive dealing where dealers use manufacturer-provided investments to sell rival brands. Exclusive dealing is shown to prevent dealers from using their promotional efforts that have been paid for by the manufacturer to sell alternative brands even when manufacturers have not made any investments that dealers may use to sell rival products. Exclusive dealing also decreases the incentive of dealers to supply less promotion than the manufacturer has paid for by creating dealers with “undivided loyalty” who therefore have an increased independent economic incentive to more actively promote the manufacturer’s products. Although an undivided dealer loyalty rationale has been accepted by some courts as a procompetitive motivation for exclusive dealing, it has been rejected in the economics literature, and recently also rejected in Dentsply. Our analysis provides an economic basis for this common sense, but previously unproven, proposition that exclusive dealing increases independent dealer incentives to more actively promote a manufacturer’s product.

Slotting fees, per-unit-time payments made by manufacturers to retailers for shelf space, have become increasingly prevalent in grocery retailing. Shelf space contracts are shown to be a consequence of the normal competitive process when retailer shelf space is promotional, in the sense that the shelf space induces profitable incremental individual manufacturer sales without drawing customers from competing stores. In these circumstances, retailer and manufacturer incentives do not coincide with regard to the provision of promotional shelf space, and manufacturers must enter shelf space contracts with retailers. Retailers are compensated for supplying promotional shelf space at least partially with a per-unit-time slotting fee when interretailer price competition on the particular product makes compensation with a lower wholesale price a more costly way to generate equilibrium retailer shelf space rents. Our theory implies that slotting will be positively related to manufacturer incremental profit margins, a fact that explains both the growth and the incidence across products of slotting contracts in grocery retailing.

Abstract The Fisher Body–General Motors case illustrates the costs of using inherently imperfect long‐term contracts to solve potential holdup problems, and therefore the advantages of vertical integration. Fisher Body held up General Motors by renegotiating its body supply contract so that, contrary to the original understanding, General Motors made half of the required investments in new body plants. This led to a decline in Fisher Body’s capital to sales ratio and, under the unchanged cost‐plus contract terms designed to provide Fisher Body with a return on its equity capital investments, produced a substantial wealth transfer from General Motors to Fisher Body. General Motors accepted this unfavourable contract adjustment because it was operating under a long‐term exclusive dealing contract that limited its ability to negotiate with Fisher over co‐located body plants. The exclusive dealing contract designed to protect Fisher Body’s original GM‐specific capacity investments against a potential holdup by General Motors thereby created a Fisher Body holdup of General Motors. The way in which Fisher Body accomplished its holdup demonstrates the importance of distinguishing inefficient holdup threats from efficient actual holdups.

Standard economics provides a well-understood framework of the competitive determinants of market prices that is now widely accepted for antitrust analysis. In “two-sidedmarkets,” where firms supply products demanded by two interrelated groups of consumers, these competitive forces operate in a somewhat more complex way and understanding the antitrust implications requires extending the standard framework. For example, a newspaper publisher faces demand from both readers and advertisers. The publisher must balance demand on the two sides of the market in determining two interrelated sets of prices, taking account of the fact that lowering subscription prices and thereby increasing readership will increase advertising prices. These “network effects” of increased readership on advertising value are what make the economic analysis unique and the antitrust implications somewhat unfamiliar.

Category management is a business technique by which a retailer designates a manufacturer as a product category manager or captain and gives the designated manufacturer authority concerning retail shelf space allocation, promotion, product assortment and inventory decisions. In return, the retailer receives a lower wholesale price or a per unit time payment. Increasing antitrust scrutiny has been applied to category manager arrangements, exemplified by the Sixth Circuit's recent decision in Conwood Co. v. United States Tobacco. Co. This paper analyzes the law and economics of such arrangements. Manufacturer payments for retail distribution (shelf space) are shown to be an element of the normal competitive process. Why this competition for retail distribution may also result in a shift in control over the shelf space allocation decision from the retailer to a manufacturer is then analyzed. Finally, the paper examines current antitrust policy with regard to category management. Category management is shown to be a pro-competitive aspect of retailing arrangements that benefits consumers.