When Do Intrabrand Non-Price Vertical Restraints Become Unreasonable?

Abstract

Intrabrand non-price vertical restraints emerge from agreements between upstream and downstream firms and impose conditions on the downstream firm’s resale of products. They are prevalent in the economy, especially in consumer-facing industries. Following the Supreme Court’s 1977 decision in Sylvania, these restrictions have been subject to the rule of reason. In Sylvania, the Court noted that these restraints incentivize downstream firms to invest in product launches and brand promotion. Yet, if one of the main objectives of these restraints is to facilitate brand building and product introduction, a question arises as to whether they should be revisited at some point in the product’s lifecycle. This paper argues that intrabrand non-price vertical restraints should be limited in duration. The initial phase of exclusivity incentivizes downstream firms to invest in new products and brands. But once these products gain recognition and firms recoup their investment, exclusivity starts maintaining prices above competitive levels without offering any countervailing competitive benefits. At this point, these restraints should be found unreasonable. To substantiate this framework, this paper presents both a novel economic model and a new empirical study of the exclusive territory provisions in the ready-to-drink beverage industry. It shows that when third-party distributors violate exclusive territories, prices of both affected and rival products decrease. Additionally, product sales in the affected territories either experience an increase or remain stable, suggesting a lack of significant decline in product quality. However, the breach of the exclusive territories leads to a reduction in product variety, underscoring the significance of these restraints for downstream investment in new products.