Vertical Integration and Antitrust Policy
01 Aug 1950-Journal of Political Economy (The University of Chicago Press)-Vol. 58, Iss: 4, pp 347-352
TL;DR: In this article, the authors show that the United States Supreme Court is mistaken in its implied assumption respecting the influence of integration upon competition and that vertical integration may not, as such, serve to reduce competition and may, if the economy is already ridden by deviations from competition, operate to intensify competition.
Abstract: RECENT decisions suggest that the United States Supreme Court is beginning to look upon integration as illegal per se, under the antitrust laws. It may be presumed, in so far as this inference is valid, that the Court believes that integration necessarily reduces competition "unreasonably."2 No sharp distinction is made by the Court between vertical and horizontal integration. It is the purpose of this note to show that the Court is mistaken in its implied assumption respecting the influence of integration upon competition. Horizontal integration may, and frequently does, make for higher prices and a less satisfactory allocation of resources than does pure or workable competition. Vertical integration, on the contrary, does not, as such, serve to reduce competition and may, if the economy is already ridden by deviations from competition, operate to intensify competition. My argument will be confined largely to this last proposition.
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TL;DR: This chapter extends the newsvendor model by allowing the retailer to choose the retail price in addition to the stocking quantity, and discusses an infinite horizon stochastic demand model in which the retailer receives replenishments from a supplier after a constant lead time.
Abstract: Publisher Summary This chapter reviews the supply chain coordination with contracts. Numerous supply chain models are discussed. In each model, the supply chain optimal actions are identified. The chapter extends the newsvendor model by allowing the retailer to choose the retail price in addition to the stocking quantity. Coordination is more complex in this setting because the incentives provided to align one action might cause distortions with the other action. The newsvendor model is also extended by allowing the retailer to exert costly effort to increase demand. Coordination is challenging because the retailer's effort is noncontractible—that is, the firms cannot write contracts based on the effort chosen. The chapter also discusses an infinite horizon stochastic demand model in which the retailer receives replenishments from a supplier after a constant lead time. Coordination requires that the retailer chooses a large basestock level.
2,626 citations
TL;DR: Several limitations of revenue sharing are identified to (at least partially) explain why it is not prevalent in all industries, including cases in which revenue sharing provides only a small improvement over the administratively cheaper wholesale price contract.
Abstract: Under a revenue-sharing contract, a retailer pays a supplier a wholesale price for each unit purchased, plus a percentage of the revenue the retailer generates. Such contracts have become more prevalent in the videocassette rental industry relative to the more conventional wholesale price contract. This paper studies revenue-sharing contracts in a general supply chain model with revenues determined by each retailer's purchase quantity and price. Demand can be deterministic or stochastic and revenue is generated either from rentals or outright sales. Our model includes the case of a supplier selling to a classical fixed-price newsvendor or a price-setting newsvendor. We demonstrate that revenue sharing coordinates a supply chain with a single retailer (i.e., the retailer chooses optimal price and quantity) and arbitrarily allocates the supply chain's profit. We compare revenue sharing to a number of other supply chain contracts (e.g., buy-back contracts, price-discount contracts, quantity-flexibility contracts, sales-rebate contracts, franchise contracts, and quantity discounts). We find that revenue sharing is equivalent to buybacks in the newsvendor case and equivalent to price discounts in the price-setting newsvendor case. Revenue sharing also coordinates a supply chain with retailers competing in quantities, e.g., Cournot competitors or competing newsvendors with fixed prices. Despite its numerous merits, we identify several limitations of revenue sharing to (at least partially) explain why it is not prevalent in all industries. In particular, we characterize cases in which revenue sharing provides only a small improvement over the administratively cheaper wholesale price contract. Additionally, revenue sharing does not coordinate a supply chain with demand that depends on costly retail effort. We develop a variation on revenue sharing for this setting.
2,271 citations
Cites background from "Vertical Integration and Antitrust ..."
...It is well known that in this setting the supply chain’s pro…t is less than optimal whenever the supplier charges a wholesale price above marginal cost because then the retailer orders fewer units than optimal (Spengler, 1950)....
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...cost because then the retailer orders fewer units than optimal ( Spengler, 1950 )....
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TL;DR: This model constructs a price-setting game between a manufacturer and its independent retailer and shows that the mere threat of introducing the direct channel can increase the manufacturer's negotiated share of cooperative profits even if price efficiency is obtained by using other business practices.
Abstract: The advent of e-commerce has prompted many manufacturers to redesign their traditional channel structures by engaging in direct sales. The model conceptualizes the impact of customer acceptance of a direct channel, the degree to which customers accept a direct channel as a substitute for shopping at a traditional store, on supply-chain design. The customer acceptance of a direct channel can be strong enough that an indepent manufacturer would open a direct channel to compete with its own retailers. Here, direct marketing is used for strategic channel control purposes even though it is inefficient on its own and, surprisingly, it can profit the manufacturer even when so direct sales occur. Specifically, we construct a price-setting game between a manufacturer and its independent retailer. Direct marketing, which indirectly increases the flow of profits through the retail channel, helps the manufacturer improve overall profitability by reducing the degree of inefficient price double marginalization. While operated by the manufacturer to constrain the retailer's pricing behavior, the direct channel may not always be detrimental to the retailer because it will be accompanied by a wholesale price reduction. This combination of manufacturer pull and push can benefit the retailer in equilibrium. Finally, we show that the mere threat of introducing the direct channel can increase the manufacturer's negotiated share of cooperative profits even if price efficiency is obtained by using other business practices.
1,449 citations
Cites background from "Vertical Integration and Antitrust ..."
...…decision.2 Each firm does the best that it can, but they independently seek high-profit margins, and as a result, the price is higher and sales volume and profits are lower than that of a vertically integrated channel.3 This is the well-known “double marginalization” result of Spengler (1950)....
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TL;DR: A mild restriction satisfied by many common distributions is developed that assures that the manufacturer's problem is readily amenable to analysis, and factors that may lead the manufacturer to set a wholesale price below that which would maximize her profit are explored.
Abstract: We consider a simple supply-chain contract in which a manufacturer sells to a retailer facing a newsvendor problem and the lone contract parameter is a wholesale price. We develop a mild restriction satisfied by many common distributions that assures that the manufacturer's problem is readily amenable to analysis. The manufacturer's profit and sales quantity increase with market size, but the resulting wholesale price depends on how the market grows. For the cases we consider, we identify relative variability (i.e., the coefficient of variation) as key: As relative variability decreases, the retailer's price sensitivity decreases, the wholesale price increases, the decentralized system becomes more efficient (i.e., captures a greater share of potential profit), and the manufacturer's share of realized profit increases. Decreasing relative variability, however, may leave the retailer severely disadvantaged as the higher wholesale price reduces his profitability. We explore factors that may lead the manufacturer to set a wholesale price below that which would maximize her profit, concentrating on retailer participation in forecasting and retailer power. As these and other considerations can result in a wholesale price below what we initially suggest, our base model represents a worst-case analysis of supply-chain performance.
1,018 citations
Additional excerpts
...Economists attribute this to ‘‘double margin- alization’’ (Spengler 1950)....
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...Economists attribute this to ‘‘double marginalization’’ (Spengler 1950)....
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TL;DR: In this article, the authors consider a supply chain consisting of two independent agents, a supplier e.g., a manufacturer and a retailer, the latter serving an uncertain market demand.
Abstract: Consider a supply chain consisting of two independent agents, a supplier e.g., a manufacturer and its customer e.g., a retailer, the latter in turn serving an uncertain market demand. To reconcile manufacturing/procurement time lags with a need for timely response to the market, such supply chains often must commit resources to production quantities based on forecasted rather than realized demand.
The customer typically provides a planning forecast of its intended purchase, which does not entail commitment. Benefiting from overproduction while not bearing the immediate costs, the customer has incentive to initially overforecast before eventually purchasing a lesser quantity. The supplier must in turn anticipate such behavior in its production quantity decision. This individually rational behavior results in an inefficient supply chain.
This paper models the incentives of the two parties, identifying causes of inefficiency and suggesting remedies. Particular attention is given to the Quantity Flexibility QF contract, which couples the customer's commitment to purchase no less than a certain percentage below the forecast with the supplier's guarantee to deliver up to a certain percentage above. Under certain conditions, this method can allocate the costs of market demand uncertainty so as to lead the individually motivated supplier and customer to the systemwide optimal outcome. We characterize the implications of QF contracts for the behavior and performance of both parties, and the supply chain as a whole.
902 citations