Resale Price Maintenance and Collusion

The paper revisits the conventional wisdom according to which vertical restrictions on retail prices help upstream firms to collude. We analyze the scope for collusion with and without resale price maintenance (RPM) when retailers observe local shocks on demand or retail costs. In the absence of RPM, retail prices react to retailers’ information and deviations from collusive behavior are thus difficult to detect. By eliminating retail price flexibility, RPM facilitates the detection of deviations but reduces profits and increases the short-run gains from a deviation. Overall, RPM can facilitate collusion and it reduces total welfare whenever firms choose to adopt it. Non Technical Summary The paper revisits the conventional wisdom according to which vertical restrictions on retail prices help upstream firms to collude. Although competition authorities’ attitude towards vertical restraints varies substantially across countries, price restrictions are often treated less favorably than non-price restrictions such as exclusive territories, selective distribution, etc. While there are some variations according to the nature of the price restriction, Resale Price Maintenance (RPM) is for example generally viewed as per se illegal or, at the very least, as most probably undesirable. This consensus against RPM contrasts with the economic analysis of vertical restraints, which shows that both price and non-price vertical restrictions may either improve or harm economic efficiency – and often provide alternative ways to achieve the same objective. Furthermore, most of the arguments made by the courts to justify their tolerant attitude towards non-price restrictions would apply as well to RPM . There is, however, one argument made in practice against RPM , which is that it could facilitate horizontal agreements. The present paper explores this argument in more detail and starts from the idea that, under RPM , retail prices are centrally set by the manufacturer and thus do not fully adjust to local variations on retail costs or demand; as a result, retail prices are more uniform under RPM , and deviations from a tacit agreement are thus more easily detected; it follows that RPM , while being less efficient since it generates less flexible prices, can be adopted to facilitate interbrand collusion. In our model, long-lived producers sell to short-sighted retailers. In each period, each producer signs an exclusive contract with a retailer. Demand is stochastic, and retailers receive private information on their demand after contracting but before the good is delivered to the market. Retail prices, but not wholesale prices, are observable by competitors. We derive the most profitable collusive equilibrium in two cases: in the first case, vertical contracts are restricted to franchise contracts while in the second case, producers can moreover control the retail price (RPM). When RPM is banned, retail prices react to retailers’ information, which makes it harder to detect a deviation from collusive behavior. By eliminating retailers’ pricing discretion, RPM facilitates the detection of such deviations. On the other hand, RPM rigidifies retail prices and, ceteris paribus, reduces profits; it thereby raises the short-run incentives to deviate. We characterize the situations where RPM effectively increases collusive equilibrium profits.