Tying Arrangements and Lawful Alternatives: Transaction Costs Considerations
24 Pages Posted: 20 Feb 2011 Last revised: 21 Aug 2011
Date Written: September 2011
Tying arrangements often increase welfare by promoting product quality and protecting the supplier's goodwill in the tying product. When the tying product works effectively only with ancillary materials or accessories or services of a particular kind or quality, its supplier can assure the requisite quality of the ancillary product only by supplying that product itself. The cost savings defense and the defenses of quality control or good will are the most widely recognized and accepted tying defenses.
One characteristic of manufactured products is differentiation among the offerings of various brands. This in turn produces a need for more specialized provision of such things as supplies, aftermarket parts, and service, thus requiring firms to dedicate their production or distribution to particular product designs. As a consequence firms must also dedicate their production and organization to ongoing relationships with a narrow range of other firms. Franchising is an one example, but there are others. What virtually all of these situations have in common is that they occur in markets that involve differentiated, typically branded products and fairly specialized aftermarket products or services. Or alternatively, a manufacturer of a complex or delicate machine may require users to have the machine serviced by the manufacturer's own employees or agents. A tie might be used in such cases by a firm with no power in the tying market and with no purpose or effect of gaining power in the tied market or even of exploiting customers.
This paper considers transaction cost rationales for tying in the context of the types of asset specificity that are common in modern relational contracts, looking particularly at protection of goodwill, manufacturer-supplied specifications or standards as an alternative to tying, and the use of tying to protect a supplier’s trade secrets.
Problematically, many of the litigated ties have involved foreclosure of only a minuscule portion of the tied market. Requiring a significant foreclosure before finding prima facie illegality would often obviate the many vexing questions concerning either cost savings or quality control. Asset specificity is ubiquitous, and serves to explain ties in many competitive markets, including franchising, office equipment, and medical services to name a few. A non-foreclosing tie ordinarily has no anticompetitive effects. Under a rule of reason treatment no justification would be required for legality, but even under harsher treatment provable quality protection should defend the tie.
Keywords: antitrust, tying, foreclosure, goodwill, transaction costs, product differentiation
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