Naked Exclusion: Comment

The ability of an incumbent firm to deter entry by writing exclusionary contracts with customers has been a subject of contention in the antitrust literature. The courts’ concern with such exclusionary contracts has been challenged by those who argue that an incumbent, faced with buyers whose interest is to promote entry and competition, would have to pay buyers more for the inclusion of exclusionary provisions than it could possibly gain from exclusion. In a provocative article, Eric B. Rasmusen et al. (1991) (henceforth, RRW) have argued that an incumbent may in fact be able to exclude rivals profitably using such contractual provisions because it can exploit buyers’ lack of coordination. In essence, if buyers expect other buyers to sign such provisions, then they may see little reason not to do so themselves. The RRW argument is potentially an important one because most alleged instances of entry deterrence through exclusionary contracts with customers occur in situations with multiple buyers. Unfortunately, however, RRW’s two main results contain errors. In this Note, we reconsider the RRW model, providing correct characterizations of the likelihood and cost of exclusion for an incumbent firm. Our results indicate that while the intuition suggested by RRW is valid, the equilibrium likelihood and cost of exclusion differ from what RRW derive. Moreover, our analysis illuminates some further aspects of exclusionary contracting with multiple buyers. Among these issues, we focus on how an incumbent can use discriminatory offers to exploit the externalities that exist among buyers in the provision of competition. In Section I, we review the basic assumptions of the RRW model. In Sections II and III we then consider, in turn, the cases of simultaneous and sequential offers studied by RRW. For the simultaneous model, we distinguish between settings in which the incumbent can and cannot discriminate in its offers to different buyers. (This distinction is the source of the problem in RRW’s analysis: their simultaneous-offer model assumes no discrimination, but the proof of their Proposition 2 assumes—at times—that discrimination is feasible.) We show that absent the ability to discriminate, the incumbent can exclude profitably only when buyers fail to coordinate on their most preferred continuation equilibrium. In contrast, we show that when discrimination is possible, the incumbent need not rely on a lack of buyer coordination to * Segal: Department of Economics, Landau Building, Stanford University, Stanford, CA 94305 (e-mail: ilya.segal@stanford.edu); Whinston: Department of Economics, Northwestern University, 2003 Sheridan Road, Evanston, IL 60208 (e-mail: mwhinston@nwu.edu). We thank Eric Rasmusen, John Wiley, and participants in the Berkeley-Stanford IOfest, the University of Copenhagen Vertical Restraints Conference, and a seminar at the Antitrust Division of the U.S. Department of Justice for helpful comments. We thank Federico Echenique for excellent research assistance. 1 For example, a recent Department of Justice investigation concerned the use of exclusive contracts by the leading provider of computerized ticketing services, Ticketmaster. Most major cities have several large concert/sports venues. In many cities, Ticketmaster has exclusive contracts with a very large share of these venues. 2 The other leading response to the argument that contracts with buyers cannot be a profitable method of exclusion is given in Philippe Aghion and Patrick Bolton (1987 Section I). One factor limiting the applicability of the Aghion and Bolton theory, however, is that it involves partial exclusion: the contracts signed are not fully exclusionary (they involve finite stipulated damages) and the profitability of the strategy arises from extracting rents from an entrant when entry occurs. Indeed, in the Aghion and Bolton model, contracts that fully exclude offer no benefits over writing no contract at all. In Section III of their paper, Aghion and Bolton also discuss a two-buyer version of their model in which externalities arise across buyers. In contrast to the analysis here and in RRW, they allow the incumbent to make an offer to a buyer i that is conditional on the acceptance decision of the other buyer. 3 R. Innes and R. J. Sexton (1994) also discuss the use of discriminatory offers in the context of a model in which buyers can form coalitions with the entrant.