Vertical restraints refer to agreements made between two or more parties who operate at different levels of the supply chain. These restraints govern the conduct between the parties involved in the production, distribution, or sale of a good or service. In this article, we will explore the nature of vertical restraints, their types, and the effects they can have on the economy.
What are Vertical Restraints?
Vertical restraints are agreements between firms that operate at different levels of production and distribution. These restraints attempt to govern the conduct of the parties involved in the production, distribution or sale of a good or service. These agreements can take many forms, including exclusive dealing, exclusive territories, tying, and resale price maintenance among others.
Types of Vertical Restraints
There are numerous types of vertical restraints, but some of the most common include:
1. Exclusive Dealing: This happens when a manufacturer contracts with a distributor or retailer not to distribute goods of a competing manufacturer.
2. Exclusive Territories: In this case, a manufacturer agrees to sell its products exclusively in a certain geographical area with only one distributor allowed in that area.
3. Tying: This occurs when the purchase of one product is tied to the purchase of another product from the same supplier.
4. Resale Price Maintenance: This involves a supplier setting the minimum price for which its product can be resold by its customers.
Effects of Vertical Restraints
Vertical restraints can have a range of effects on the economy. In some cases, vertical restraints may be anti-competitive, leading to higher prices for consumers and reduced efficiency in the marketplace. However, in other situations, vertical restraints can also be pro-competitive, allowing firms to address issues like free riding, ensuring quality control and financing services related to distribution.
Pro-competitive Vertical Restraints
Pro-competitive vertical restraints can, for instance, promote the investments of producers in quality control or warranty provisions, which can lead to better services and products. Since there is an assurance of high-quality products and services, customers are more likely to purchase products from that manufacturer, which may lead to the market dominant position. Thereby encouraging innovative product improvements through the increased revenue.
Anti-competitive Vertical Restraints
Vertical restraints that are anti-competitive, may lead to a less competitive marketplace that might result in the prices of products and services to be higher than if the market was more competitive. Anti-competitive vertical restraints could also result in the foreclosure of competition and market access.
In conclusion, understanding vertical restraints is vital for both business owners and regulators. While some vertical restraints may be pro-competitive and beneficial for the economy, others may have anti-competitive effects that are harmful to the consumers. Therefore, appropriate measures need to be undertaken to ensure that vertical restraints are consistent with antitrust law and do not unfairly restrict competition. The goal for regulators is balancing the benefits of constraining potentially harmful practices and not dampening the potential improvements from pro-competitive vertical restraints.
Antitrust laws have evolved greatly over the years to include a wide range of business practices. However, most antitrust laws can trace their beginning back to the Sherman Antitrust Act of 1890. The main focus then was to draft a form of competition law that would ensure fair interstate commerce.
As one could imagine, business will always find a way to maximize their benefit at the expense of their competitors. This is where competition law is most important as it addresses the many different forms of restrain that can be placed on commerce. The antitrust laws of the Sherman Act address mainly two forms of restraint that manifest in a variety of ways: horizontal restraint and vertical restraint.
Many of the horizontal restraint types of infractions are obvious, either concerning price fixing or bid rigging. However, vertical restraints on interstate commerce are much different. By vertically integrating business operations, companies can drastically reduce their operational costs and, in turn, raise revenues.
Not all forms of vertical integration are legal. In fact, some are very illegal. There are a variety of ways to violate forms of competition law through vertical integration. One of the most common is in-house vertical integration. This occurs when a company seeks to acquire dominance at every level of production. This type of situation is covered in much greater depth in Section 2 of the Sherman Antitrust Act.
For example, a car manufacturer makes and sells the automobile, but if they also were to produce all the parts themselves and gather all the materials themselves, this would become a vertically integrated company in breach of the Sherman Antitrust Laws.
This occurred most frequently during the turn of the 20th century as many manufactures came to realize that owning all the parts in the manufacturing process cut their costs dramatically and gave them absolute control. While it may allow for a smoother business model, it also destroys any level of competitiveness in the market.
Competition was a central concern of Senator John Sherman, the man who developed the early antitrust laws, as even prior to 1890 he saw a rapid decline of competition within US industry. One way that companies got around this blatant form of vertical integration was through contracts and exclusionary practices. Large businesses have the capital to choose who will manufacture the smaller elements found within their products.
In a fair market the contracts would be up for bidding, but some companies engage in the practice of bid rigging or excluding certain manufacturers of even having a chance to compete. By doing this they were able to streamline their manufacturing and, in some cases, even hinted where the manufacturers should buy their resources. Once again, this would violate any form of fair competition law.
Depending on how blatant the infraction is, either the per se method of legal interpretation of company behavior or the rule of reason method is employed. In some cases, while there is a level of vertical integration, due to the rule of reason it can actually produce even more competition within a given sector. Therefore, those business practices would not be in violation of any statute found within the Sherman Antitrust Act.