Adverse Selection and Partial Exclusive Dealing

I reconcile a disagreement in the literature regarding the impact of downstream price competition on anticompetitive exclusive dealing, and then extend the exclusive dealing literature to accommodate adverse selection. Adverse selection expands the scope of inefficient exclusion, and may also explain policies of partial exclusion, in which an incumbent profits by locking up select retailers even though the entrant’s product is still competitively supplied in equilibrium. I relate my results to recent antitrust cases against Intel. Consider a market entrant facing two key challenges: gaining access to consumers and convincing them that it sells a good product. These challenges are particularly dire because the incumbent may curtail the entrant’s access to consumers by offering retailers exclusive contracts, and because the market is afflicted by adverse selection regarding the entrant. I investigate the prospects for this entrant and the health of the overall market. I show that the scope of anticompetitive exclusive dealing is strongly influenced by adverse selection, and that jointly considering adverse selection and exclusive dealing leads to new insights on how regulators ought to look at exclusive dealing cases. For example, I show that the incumbent may gain from a policy of partial exclusion in which only select retailers are locked into exclusive contracts, seriously impairing competition—even though the entrant’s product is readily available to all consumers through other retailers. Indeed, I argue that this helps explain facts surrounding the recent US and EU cases against Intel. It may seem surprising that jointly studying exclusive dealing and adverse selection is useful. After all, it is already known that an incumbent can use exclusive deals to lock an entrant out of the market. For example, Rasmusen, Ramseyer, and Wiley (1991) and Segal and Whinston (2000) show that when an entrant faces fixed costs which can only be cleared by serving multiple end buyers, an incumbent can use a divide-and-conquer strategy to exclude the entrant at virtually zero cost. If the anticompetitive role of exclusive contracts is so clear, and the results so extreme, what is gained by incorporating adverse selection? The kernel of the answer to this question lies in a series of recent papers that together suggest that, in fact, the scope for anticompetitive exclusive dealing is far from settled even in the absence of adverse selection. Fumagalli and Motta (2006), Simpson and Wickelgren (2007), and Abito and Wright (2008) all note that most prior analyses on (the anticompetitive effects of) exclusive dealing abstract away from downstream competition. Radically different conclusions on the impact of such downstream competition are reached by these authors, Johnson Graduate School of Management, Cornell University. Email: [email protected].