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Loyalty Rebates
10/29/06
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Do full-line rivals exist MOTIVATIONS AND EFFECTS OF BUNDLING DIFFER ACROSS THESE CASES NOT LOST IN THE DESERT. CAN USE SAME TOOLS TO ANALYZE EFFECT ON COMPETITION
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#1 Hard to Justify Negative Prices
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We see negative prices as a result of discounts that go backto unit one. Issue arises both with single product and multi-productrebates
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One solution is to have discounts be on incremental volume. Not anti-consumer. Discounts can be bigger.
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Create No-Cost Predation The way it works is that price of A is inflated if you don’t buy B. Normal monopoly price of A is 100 But if don’t buy my B, then have to pay 120 for A. Point is that no one actually pays 120. This is a threat that, if credible,
Unlike regular predation, where firm actually has to sell product
at Since it is less costly to employ (no recoupment required), greater
risk to
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Rival would have to charge -$185,731 to be competitive
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is Practical Detection Device Firm with market power in A also sells good B and faces competition in B. Firm prices A-B bundle such that incremental price of A-B over A alone isless than cost of B. Result: Equally efficient rivals selling only Bare foreclosed Horizontal parallel to vertical price squeeze.
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Incumbent would seem to be losing money by selling bundle over A alone. (Price of A alone may be artificially high.) No need to look at cost of rival. No hypothetical equallyefficient rival. Easy for incumbent to know if its prices satisfy this test ornot. Could use variable cost and average cost as safeharbor and danger zone. Did price of A go up or did price of A-B bundle go down.
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This is especially important in case where products in bundleare substitutes Incumbent firm has market power in good A B is a substitute. Think of A as Scotch tape and B as generic tape or A asKeflin and B as Kefzol (two cephalosporins).
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Reduce price of Kefzol to compete with Ancef Problem (from Lilly perspective) is that this increases substitution of Kefzol for Keflin (biggest money maker) Consumers win on two counts: lower Kefzol price and more use of Kefzol
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Give overall rebate if buy Kefzol Ancef’s lower price doesn’t offset rebate Now incremental price of Kefzol remains high Thus much less incentive to substitute Kefzol for Keflin As if Lilly says: We will give you 100 units of Kefzol for free provided you agree not to use anymore than that
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If 3M matches/beats LePage’s on price of generic tape, more people will substitute generic for Scotch® tape. How to beat LePage’s without lowering price? Give 3% discount across the board Rebate savings offset higher price. But high price of generic doesn’t threaten Scotch® Rebate is paid as lump-sum fee so it isn’t passed on to consumers of generic tape
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Easy to tell that $2.93 is cheaper than $2.97 Is 3% off A & B if you buy B a good deal or not? Rival in B needs to forecast how much A customer will buy in order to offer competitive price. This isn’t rival’s business. Recall how hard it was to read chart with negative prices. Shouldn’t require an MBA to figure out lowest price.17
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Depend on Who Else Customer Buys From Price might depend on how much customer buys in total Price might depend on how much more customer buyscompared to last year Buy why should customer pay higher price based on whatcustomer does with other vendors, holding sales with thisfirm constant? This is case of raising rivals’ costs. Effect may be the same via total volume discounts. But ingrowing market, this will create room for rivals.
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Discount Justifications Often said that justification for bundling is that customers likebundles. Okay. But if that is correct, then bundle shouldbe sold at a premium, not a discount. Cases where A and B are used in fixed proportion. If so,then no possibility of price discrimination. Price discrimination works best when goods in bundle havenegative correlation in value (Opera tickets and Wrestlingtickets). Hard to find examples of bundles with negativecorrelation. All bundles seen in antitrust cases have positive correlation.
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Leverage (& Protect) Market Power Demand for A is Q = 10 -P. Cost is zero. Thus monopoly price is 5. Monopoly profit is 5*5 = 25. B is competitive. Cost is 1. Price is 1. Demand for B is one unit. Chicago School: Don’t sell A&B at 6. Better to sell A alone at 5. New School: If buy my B, price of A is 4. If don’t buy my B, price of A is 6. Customer loses at least 8 by not buying B. (Pays an extra 2 on 4 units) Thus willing to pay up to 9 on B in order to get A discount. A discount only costs the firm 1 as 4*6 = 24, versus 5*5 = 25. Thus monopolist is up 7+ Explanation: Monopoly is inefficient. Monopolist agrees to be less bad on A if customer does a favor and buys overpriced B.
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Bundle discounts make it hard for single-product rivals to compete One discount protects two flanks A is 10, B is 10, A-B is 16 Single product rival has to price below 6 in either A or B But incumbent gets 8 --Consumers pay 8 Reason not to apply test of whether overall bundle is above cost
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Under Strong Assumptions But Misses Interesting Cases Even if one monopoly profit, that profit may be larger under price discrimination than if no loyalty discounts. Consumers lose. May choose to exclude because of dynamic considerations. Not a one-shot game. It is generally possible and profitable to leverage monopoly intocompetitive market. Bundle discounts can protect incumbent with dual market power from entry into either market. Bundling and tying provide the potential for no-cost foreclosure. The effect is the same as predatory pricing, but it may be done at no cost to the firm
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of Bundling Without Exclusion Bundles versus bundles is generally more competitive than items versus items. Bundles solve double markup problem Thus bundlers also have advantage over mono-line rivals Get competitive gain without exclusion
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