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Hub-and Spoke arrangements – BENNETT – December 2019 OECD discussion

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This presentation by Matthew Bennet, Vice president, Charles Rivers Associates, was made during the discussion “Hub-and-spoke arrangements” held at the 132nd meeting of the OECD Competition Committee on 4 December 2019. More papers and presentations on the topic can be found at oe.cd/hsa.

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Hub-and Spoke arrangements – BENNETT – December 2019 OECD discussion

  1. 1. The economics of Hub and Spoke Agreements Matthew Bennett Vice President, CRA 1
  2. 2. Matthew Bennett December 2019 Structure Overview Economics of hub and spoke Applying economics to law? Conclusions 2
  3. 3. Matthew Bennett December 2019 Why hub and spoke enforcement? Want to prevent firms from colluding. • Therefore rule out agreements between firms to set prices. But what happens if firms just talk about intentions without explicitly agreeing to collude? • Don’t want firms to be able to bypass law. • Thus may want to take hard line on some exchanges, e.g. future pricing intentions between competitors. What happens if firms have same discussion through third parties? • Again – don’t want firms to bypass law. • Thus may be concerned by some discussions of prices between independent parties if believe they are intended to be passed on to rivals. 3
  4. 4. 1. The economics of “hub and spoke” exchanges 4
  5. 5. Matthew Bennett December 2019 Two broad cases of hub and spoke Retailer Supplier A Supplier B Price info Price info Supplier to Retailer to Supplier Retailer to Supplier to Retailer Supplier Retailer A Retailer B Price info Price info 5
  6. 6. Matthew Bennett December 2019 Supplier to Retailer to Supplier Theory of harm Flow of information may allow coordinated outcomes between suppliers. Note however that exchanging information through a third party is generally more difficult than direct: • Coordination often requires trust built up through direct communication • Third parties may have differing incentives particularly in vertical relationships 6 Retailer Supplier A Supplier B A’s price info A’s price info B’s price info B’s price info
  7. 7. Matthew Bennett December 2019 Supplier to Retailer to Supplier Retailer incentives to participate? In simple model may not expect retailers to have an incentive to pass through information that facilitates higher supplier prices: • It directly increases their costs and hence reduces their profits (even if all their competitors follow). However retailers may still act as a conduit for exchanges: • If suppliers have market power (must have) retailers may have little choice. • Non-linear prices - Suppliers may provide retailers with discounts or rebates (e.g. side payments) to provide retailers with incentives (i.e. as long as total profits go up, it can reallocated). • Retailers may be focused on ensuring parity between their rivals rather than lower input prices for themselves. 7 Retailer Supplier A Supplier B Price info Price info
  8. 8. Matthew Bennett December 2019 Supplier to Retailer to Supplier Pro-competitive effects Pro-competitive effects Competitive S2R2S exchanges may be very common, even more so than direct exchanges. • Retailers will regularly go back and forth to suppliers to get the best possible price from a supplier. • Retailers may quote prices from a supplier’s competitor in order to negotiate a lower price from the supplier. • Ruling out such behaviour may rule out retailers’ ability to bargain and increase consumer prices. Balancing Over all suggests one should be much more cautious in pursuing an indirect exchange of information via a retailer than a direct exchange. • Coordinating through third parties is generally harder than direct coordination. • There are reduced incentives for retailers to facilitate them (relative to direct exchanges). • There are much more frequent and stronger benefits in vertical set-up. However this does not mean cases do not exist! 8
  9. 9. Matthew Bennett December 2019 Retailer to Supplier to Retailer Theory of harm Flow of information may allow coordinated outcomes between retailers. Supplier Retailer A Retailer B A’s price info B’s price info B’s price info A’s price info 9
  10. 10. Matthew Bennett December 2019 Retailer to Supplier to Retailer Supplier Incentives? Suppliers may not want to pass information that facilitates higher retailer prices: • It increases retailer price, reduces retail sales and hence demand and thus reduces supplier profits, even if all rivals follow. But suppliers may still facilitate exchanges: • Bargaining power - if suppliers need access to retailers (must have) then suppliers may have little choice. • If competing suppliers face similar agreements, then there may be less incentive to fight back against retailers. • May allow suppliers to reduce retailers bargaining power thus increasing their share of the pie (even if overall pie is reduced), see next slide. 10 Supplier Retailer A Retailer B Price info Price info
  11. 11. Matthew Bennett December 2019 Retailer to Supplier to Retailer Reduction in retailer bargaining? Supplier bargaining power story behind supplier incentives? • By reducing competition between retailers, a supplier may soften retailers’ bargaining power/incentives vis a vis itself. • If all retailers know they have the same price, they have less incentive to negotiate lower input prices from supplier. • If supplier ensures a common retail price it means no retailer can translate a wholesale cost advantage into a retail price differential and thus less incentive to bargain on wholesale prices (assuming there is a cost to bargaining). • Therefore a common retail price may increase the share of pie that the supplier gets. In a bargaining game it may result in the supplier having an increased share of the pie, even if its volumes fall. 11 Supplier Retailer A Retailer B Price info Price info
  12. 12. Matthew Bennett December 2019 Retailer to Supplier to Retailer Pro-competitive effects? Pro-competitive effects: Pro-competitive R2S2R facilitated exchanges may be more common than direct exchanges, but less common than S2R2S. • When suppliers have limited output which they need to allocate between retailers they may negotiate on the basis of the retail price – with the lowest price retailer allocated the most volumes. • When suppliers have a high value brand, they may have an incentive to have a high retail price in order to protect that brand – therefore prevent discounting. Balancing? Over all suggests one may still be more cautious about pursuing these cases than direct exchanges, but worry more about these than S2R2S cases given less obvious pro-competitive rationale. 12 Supplier Retailer A Retailer B Price info Price info
  13. 13. 2. Applying economics to law? 13
  14. 14. Matthew Bennett December 2019 What does economics say about designing a law? Want to differentiate between pro-competitive and anti-competitive: Pro-competitive • Use of information in order to bargain and extract lower prices which can be passed on downstream. Anti-competitive • One party giving information to another knowing that (or expecting that), it will be passed on to its competitor in order to coordinate. Differentiator regarding to ‘knowing’ or ‘expectation’? • In pro-competitive case there is no expectation from firm that its information will be passed onto its rival. • In anti-competitive case there is the expectation it is passed to rival. Thus perhaps use evidence of expectations of being passed on? 14
  15. 15. Matthew Bennett December 2019 The UK test: Three limb test Limb 1: A to B A discloses future pricing information to B in circumstances such that A can be assumed to intend, or does intend, that B will pass onto C 15
  16. 16. Matthew Bennett December 2019 The UK test: Three limb test Limb 1: A to B Limb 2: B to C A discloses future pricing information to B in circumstances such that A can be assumed to intend, or does intend, that B will pass onto C B passes info to C in circumstances such that C may be taken to know context in which it was passed on, and/or information is passed on with As understanding. 16
  17. 17. Matthew Bennett December 2019 The UK test: Three limb test Limb 1: A to B Limb 3: Use by C A discloses future pricing information to B in circumstances such that A can be assumed to intend, or does intend, that B will pass onto C C uses the information in determining its own future pricing intentions Limb 2: B to C B passes info to C in circumstances such that C may be taken to know context in which it was passed on, and/or information is passed on with As understanding. 17
  18. 18. Matthew Bennett December 2019 Conclusion on A2B2C cases All A2B2C cases can have the same anti-competitive effects as direct exchange cases - coordination. • But direct contact is often a key agreement to coordinating (requirement of trust). • Furthermore conduits may have incentives to resist these anti-competitive effects. • In addition there may be pro-competitive stories regarding bargaining – particularly with regards to R2S2R cases. Need for legal test that differentiates. • Legal test requirement of knowing/expectation that it will be passed on, attempts to do this. • Minimises cases of pro-competitive exchanges being wrongly prosecuted. Should conduit’s incentives play a role? 18
  19. 19. 4. Platform/Retail MFNs and Hub and Spoke 19
  20. 20. Matthew Bennett December 2019 Platform or retail MFNs (i) Platform A Platform B Retailer (1) / Hotel (1) 20 Consumers Price on platform B (P1 B)Price on platform A (P1 A) Charge for Retailer being on platform (or commission) I don’t mind what price you charge on my platform, as long as it is no different from what you are charging on Platform B (i.e. P1 A = P1 B) (P1 A) (P1 B) P1 A = P1 B
  21. 21. Matthew Bennett December 2019 Platform or retail MFNs (ii) – Potential Harm Platform A Platform B Retailer /Hotel 1 21 Consumers Price on platform B (P1 B)Price on platform A (P1 A) Charge for Retailer being on platform (or commission) I don’t mind what price you charge on my platform, as long as it is no different from what you are charging on Platform B (i.e. P1 A = P1 B) CBCA In normal competition there is a cost of increasing wholesale cost because it gets passed through to retail prices and thus results in switching to rival brands and lower volumes. MFN breaks or makes the link ‘stickier’ between wholesale price and retailer price. If Commission A goes up, then Retailer can’t increase price on platform A (P1 A) without increasing price on B as well. Incentive for Platform A to increase price increases because it knows it won’t lose any volumes to B as relative prices won’t change.
  22. 22. Matthew Bennett December 2019 Potential benefits from platform/retail MFNs Main concern is potential for platforms to face free- riding by sellers or other lower quality platforms. • Platforms undertake investments to attract buyers onto the platform. • However seller has an incentive to find buyers on the platform but then encourage them to transact off of the platform to avoid commission. 22
  23. 23. Matthew Bennett December 2019 Similar to RPM the upstream firm is constraining the downstream retailer in what it can charge to consumers. • But means of effect is not really same, in RPM direct effect is to restrict competition between two retailers, whilst indirect it softens upstream competition, whilst Platform MFN directly softens upstream i.e. doesn’t directly restrict downstream competition. Not so clear there are similarities to hub and spoke? • Coordination theory is between Platform A and B, but information flow is on the retail price, not the upstream commission. • Thus not clear any information flows facilitate a cartel beyond the softening of competition theory? Similarities may arise if there are additional clauses around requiring information disclosures on wholesale price. Similarities to RPM and information exchange? Platform A Platform B Retailer 1 23 Consumers Price on platform B (P1 B)Price on platform B (P1 B) Charge for Retailer being on platform (or commission)
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