1. 09/10/08 Bundling and Competition for Slots 1 Doh-Shin Jeon (UPF, TSE) Domenico Menicucci (Universita di Firenze) Seminar at Université de Paris X, October 9, 2008

2. 09/10/08Bundling and Competition for Slots2 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

3. 09/10/08Bundling and Competition for Slots3 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)

4. 09/10/08Bundling and Competition for Slots4 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?

5. 09/10/08Bundling and Competition for Slots5 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

6. 09/10/08Bundling and Competition for Slots6 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.

7. 09/10/08Bundling and Competition for Slots7 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

8. 09/10/08Bundling and Competition for Slots8 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…”

9. 09/10/08Bundling and Competition for Slots9 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)

10. 09/10/08Bundling and Competition for Slots10 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”

11. 09/10/08Bundling and Competition for Slots11 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

12. 09/10/08Bundling and Competition for Slots12 Chicago School Criticism Two firms (A,B) and two products (1,2) A is the monopolist of product 1 A and B compete in product 2 Zero cost of production A single buyer with unit demand for each product. Buyer’s utility: u A 1 >0, u A 2 >0, u B 2 >0 Assume u A 1 + u A 2 > u B 2

13. 09/10/08Bundling and Competition for Slots13 Chicago School Criticism Without bundling: - A sells product 2 iff u A 2  u B 2 - A’s profit: u A 1 +max{0, u A 2 - u B 2 } With bundling: - A always sells both products - A’s profit: u A 1 + u A 2 – u B 2 A has no incentive to use bundling for the purpose of monopolizing product 2

14. 09/10/08Bundling and Competition for Slots14 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

15. 09/10/08Bundling and Competition for Slots15 Illustration with a simple example Two firms (A, B) One buyer with two slots A has two products with (u A 1,u A 2 )=(4,2) B has one product with u B 1 =3 Cost of production is zero Independent values Efficiency requires A’s best product and B’s product to occupy the slots

16. 09/10/08Bundling and Competition for Slots16 No equilibrium without bundling Simultaneous pricing game Tie-breaking: when D is indifferent, D maximizes the sum of the gross values No equilibrium in which B does not sell its product -B can deviate by undercutting A’s second product’s price

17. 09/10/08Bundling and Competition for Slots17 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 p A 1 =4, p A 2 ≥2 - Then, B’s best response is to charge p B 1 =3. - Then, A has an incentive to undercut B by charging p A 1 =4, p A 2 =2- 

18. 09/10/08Bundling and Competition for Slots18 Bundling Consider pure bundling: A sells a bundle of both products In the equilibrium, P A = 4 and P B = 1. Both bundles are purchased and hence the buyer allocates the slots efficiently.

19. 09/10/08Bundling and Competition for Slots19 Intuition for efficiency Bundling gets rid of internal competition and makes external competition efficient Start from p A 1 =4, p A 2 = , Without bundling, if A charges p A 1 =4, p A 2 =0, there is cannibalization. With bundling, if A includes the second product into the bundle and charges P A =4, it makes the bundle (weakly) more attractive: adding a product into a bundle never hurts the seller

20. 09/10/08Bundling and Competition for Slots20 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

21. 09/10/08Bundling and Competition for Slots21 Model There are n firms Each firm i has n i number of products One buyer with k number of slots Products of independent values cost of production: c ≥ 0 u i j : Buyer’s gross profit from firm i’s j-th best product u i 1 ≥u i 2 ≥… ≥u i ni ≥0 W.l.o.g, n i ≥ k u j: D’s gross profit from the j-th best product among all products

22. 09/10/08Bundling and Competition for Slots22 Contracts Given a bundle of m products of firm i (Mixed) Bundling (P i,p i1,p i2,…,p im ) Pure bundling: bundling with p i1 =p i2 …=p im =0 Slotting contracts: pure bundling plus the obligation to make m slots occupied by the m products Menu of pure bundles:

23. 09/10/08Bundling and Competition for Slots23 A general result: for any c Prop 1: An efficient equilibrium always exists Each firm offers a bundle of all its products and charges p i1 =p i2 …=p ini =c (i.e. rents its technology at the cost) Remark: Deviation with pure bundling or slotting contracts is not profitable

24. 09/10/08Bundling and Competition for Slots24 Without slotting contracts: Uniqueness For c small (i.e. c< u k - u k+1 ) - Prop 2: all equilibria are efficient, regardless of the level of industry concentration For c> u k - u k+1, - Pure bundling can generate inefficient equilibria - Prop 3: Without pricing below cost (i.e. p ij ≥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 p ij =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.

25. 09/10/08Bundling and Competition for Slots25 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: P i (1)≤ P i (2) ≤ …, all equilibria are efficient

26. 09/10/08Bundling and Competition for Slots26 Equilibrium menu when c=0

27. 09/10/08Bundling and Competition for Slots27 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 P A =7 and P B =0

28. 09/10/08Bundling and Competition for Slots28 Equilibrium selection Prop: In the case of duopoly, when both firms use slotting contracts, all other equilibria are Pareto dominated by the efficient equilibrium

29. 09/10/08Bundling and Competition for Slots29 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

30. 09/10/08Bundling and Competition for Slots30 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

31. 09/10/08Bundling and Competition for Slots31 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.

32. 09/10/08Bundling and Competition for Slots32 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)

33. 09/10/08Bundling and Competition for Slots33 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

34. 09/10/08Bundling and Competition for Slots34 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

35. 09/10/08Bundling and Competition for Slots35 Future work Extension: - allow for substitutes - variable quantity - then “exclusive dealing” is a special case with n=2, ni=1 and k=2.