5.25 The production of goods and services often involves the use of multiple processes or steps. In many instances, the same firm carries out these processes or steps. In other cases, different firms are involved. With multiple firms active at different points in the production or distribution chain, the output of one firm (the “upstream” firm) becomes the input for another (the “downstream” firm). The upstream and downstream firms are said to be vertically related. 5.26 In general, it is not in the interests of a party at one
level of the supply chain to have firms at another level gain market power. Instead, parties at one level prefer to see competition at the other levels. This is because the development of market power at another level of the supply chain leads the supplier or suppliers at that level to set a price for their goods or services that is above the competitive level. This leads to a restriction in supply. This restriction in supply adversely impacts the demand for the products or services supplied at other levels of the production chain. With regard to insurance, the implication is that it is not in the interest of upstream insurers to see market power develop at the downstream intermediary level.
5.27 Upstream and downstream firms may have many different types of relationships with each other. The
simplest relationship is that of a supplier and its customer where the manufacturer sells its goods without restrictions. It is common, however, for additional contractual arrangements to be agreed between the upstream and downstream firms. This is because the success of one often depends upon the other. A retailer that works hard to promote a manufacturer’s products increases both its own unit sales and the sales of the manufacturer. As a result of this interdependence, both parties may gain if they agree to certain restrictions on their behaviour. 5.28 For example, suppose that both an upstream
manufacturer and a downstream retailer possess market power. If the manufacturer acts to restrict supply below, and increase prices above, the competitive level upstream, then the retailer will pay a price for the goods it purchases from the manufacturer that is elevated and reflects the manufacturer’s market power. The downstream retailer takes this elevated price, along with all of its other input costs, into consideration when determining its own output levels and prices. In exercising its market power
downstream, the retailer will also restrict output below the competitive level that would otherwise prevail downstream, given the prices for all of its inputs. This further attempt to increase prices and restrict the volume of goods in the marketplace is harmful to the upstream manufacturer, which sees the demand for its product fall below the level it desires. Both firms would benefit if they could jointly determine their end price to consumers. Consumers would gain as well because this end price would be below the price that would prevail if both firms separately attempted to exercise market power. The dual attempts to earn a mark-up leave consumers worse off.6
5.29 There are many other examples of situations where agreed restrictions or limitations on behaviour involving vertically-related firms improve market performance. In markets for which point-of-sale services are important to customers, for example, upstream manufacturers may set up exclusive service territories for their downstream retailers so that each retailer has incentives to provide these services. These exclusive territories restrict the behaviour of downstream retailers by limiting the geographic area in which they may make sales. Without exclusive territories, downstream sellers of the same product may locate close to one another and each may try to undercut the prices charged by the other. This may lead to very low prices, which may make it difficult for retailers to support or fund retailer services. Since these services are important to consumers, consumers benefit from the exclusive territories because they support the provision of these services.
5 A fuller account of other possible sources of competitive pressure is given in the Authority’s Notice on Guidelines for Merger Analysis, op. cit.
6 For a more detailed exposition of the successive monopoly problem, see Roger D. Blair and David L Kaserman (1983), Law and Economics of Vertical Integration and Control, New York: Academic Press, pp. 31 – 36. See also Jean Tirole (1988), The Theory of Industrial Organization, Cambridge, Mass: The MIT Press, pp. 173-175.
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5.30 Where there is sufficient competition between different “brands” upstream, vertical restraints are generally not viewed as harming competition.7Instead, they are viewed as being efficiency enhancing and pro-competitive. As with the exclusive territories example detailed above, vertical restraints provide a means of aligning interests between the upstream and downstream firm.
5.31 In certain settings, the upstream and downstream firms cannot directly contract in a way that aligns their incentives. Upstream and downstream firms can contract over the exclusive territories discussed previously because territories are observable and the resulting sales limitations are enforceable. Suppose that the upstream firm wants the downstream firm to engage in a certain level of “sales effort”. Effort itself may not be observable, and a contract that attempts directly to set effort levels would be unenforceable. Instead, the upstream firm may need to provide incentives to the downstream firm, such as sales targets.
5.32 In sum, the analysis of the impact of vertical
relationships or restraints on competition has several components. These are:
(a) Define the relevant upstream and downstream markets;
(b) Calculate market shares and determine the extent of market concentration in each market;
(c) Determine whether there is market power in either or both markets;
(d) If there is a finding of market power, then analyse whether the vertical restraint restricts competition; and
(e) If there is a restriction in competition, then analyse whether there are efficiency benefits that flow from the restriction8and whether, on balance, the restriction is harmful.9
7 See, for example, Commission Notice: Guidelines on Vertical Restraints, OJ [2000] C 291/1 (the "Vertical Restraint Guidelines") at paras. 6 and 119. 8 A list of such benefits is provided by the Vertical Restraint Guidelines at para. 116.
Insurance Market Definition and Concentration
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analysis of the 2002 statutory returns in the irish market and related matters