Academic journal article Economic Inquiry

Efficiency Effects of Exclusive Territories: Evidence from the Indiana Beer Market

Academic journal article Economic Inquiry

Efficiency Effects of Exclusive Territories: Evidence from the Indiana Beer Market

Article excerpt

I. INTRODUCTION

Vertically-imposed exclusive territories, whereby a manufacturer allows only a single dealer to market its products within a given geographical area, have been the subject of much debate among economists and the antitrust bar. At the heart of the controversy is the effect of exclusive territories on economic efficiency; do these vertical restraints enhance economic efficiency by promoting the optimal level of dealer effort or do they reduce social welfare by stifling intrabrand competition and promoting dealer cartels?

The debate over the efficiency effects of exclusive territories begs resolution by examining the available data. While exclusive territories have been used in a number of industries, we examine the beer industry in Indiana.(1) We choose the beer industry because much of the requisite information is publicly available, and sufficient variation in the regulatory structure exists to test alternative hypotheses concerning exclusive territories. We focus on Indiana because it is the only state that has legally proscribed the use of exclusive-territory contracts by brewers. Thus, time-series data from Indiana offer a unique opportunity to construct reliable tests of the effects of these vertical restraints.

In addition to data availability, the beer industry is a prime candidate for analysis since the use of vertical restraints by brewers continues to be of policy interest. Brewers and beer wholesalers have sought federal antitrust immunity for brewers that grant exclusive territories to their distributors.(2)

II. THE OPPOSING THEORIES OF EXCLUSIVE TERRITORIES

Posner [1981] and others have argued that vertical restraints are selected by manufacturers to enhance the efficiency of their distribution systems and therefore should be legal per se. Exclusive territories can enhance economic efficiency if they serve to promote provision of the optimal level of dealer services. Telser [1960] argues that in the absence of exclusive territories, dealers may fail to provide the manufacturer's optimal level of dealer services when consumers can free ride on dealer services that are associated with, but separable from the product. Additionally, Klein and Murphy [1988] suggest that if product quality is not observable by consumers prior to purchase, some dealers can profitably underproduce service levels that affect quality and free ride on performing dealers. Dealers may also fail to provide the level of service desired by the manufacturer even when consumer or producer free-riding problems do not exist. Posner [1977] and Klein and Murphy both reason that if the dealer profit margin in the absence of exclusive territories is insufficient to compensate for the dealer's cost of services like advertising displays or point-of-sale promotions, then dealers will not produce these services even when they are profitable to the manufacturer.

Klein and Murphy argue that exclusive territories serve to assure dealer provision of the manufacturer's optimal service level by restricting intrabrand competition and thus creating a stream of quasi-rents accruing to dealers. The quasi-rents serve as a reward to dealers who provide the desired level of service. Dealers who do not live up to their contractual obligations run the risk of termination and loss of future quasi-rents. The grant of exclusive territories will then have two opposing effects on final market equilibrium. To the extent that additional services are valued by consumers, demand will increase which in turn will lead to higher equilibrium price and output. In contrast, absent resale price maintenance or other vertical controls, the reduction in intrabrand competition among dealers will tend to reduce supply, causing an increase in price and a decrease in output.

Under the dealer-services hypothesis, the possible effects of exclusive territories on price and output are depicted in Figures 1 and 2. Following the actual structure of beer marketing, we consider a three-tier distribution system composed of manufacturers, wholesalers, and retailers. …

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