AFTERMARKET MONOPOLISATION: AN ANALYSIS OF THE CHICAGO AND POST-CHICAGO SCHOOLS OF THOUGHT (I)
Updated: Mar 4, 2021
This two-part post is authored by Ayushi Dubey and Yash Jain, 4th-year students of B.A.LL.B. (Hons.) at the Institute of Law, Nirma University, Ahmedabad. The second part can be accessed here.
Aftermarket is a market for the products peripheral to the primary product. In other words, “it is a special kind of antitrust market consisting of unique replacement parts, post-warranty service or other consumables specific to some primary product. It refers to markets for complementary goods and services such as maintenance, and upgrades that are required after the consumer has purchased a durable good.”[i] The primary product requires a secondary service or parts in connection for an effective long-lasting lifetime and this service is provided for by the aftermarkets. Further, the primary market and aftermarket form two distinct markets, and therefore they can either be controlled together by one firm or by two different firms. This article discusses the anti-competitive effects that arise when both the primary and aftermarket are controlled by the same entity.
Usually, to exercise control over both the markets, an enterprise engaged in the primary market also deals in its aftermarket. At the outset, the enterprise has an advantage over its competitors as the consumers are majorly dependent on that enterprise for the service of products. This increases the chance of the enterprise to monopolize in the aftermarket and thus increasing the risk of abuse of dominant position in the aftermarket.
Aftermarket monopolization can cause abuse by fixing high switching costs, i.e., costs that are incurred when switching from one supplier of a particular good/service to another supplier,[ii] or by “locking-in” the consumers with the seller which makes it difficult for the consumer to switch to other sellers. Additionally, the abuse can also take place by not voluntarily providing the necessary information to the consumer, leaving the consumers ill-informed, thus creating an information asymmetry in its favour.[iii] This leaves the buyer as a vulnerable consumer and seller enjoys the monopoly by reducing its competition in the market. On the other hand, aftermarket monopolization can also have consumer-oriented effects as it allows the manufacturers to provide quality products in the primary market by recouping the loss in the aftermarket which they have incurred in the primary market. The article further delves into the details of the debate around whether aftermarket monopolization has pro-competitive or anti-competitive justifications by discussing the two cardinal schools of thought and their application across different jurisdictions in cases of aftermarket monopolization.
2. ECONOMICS OF AFTERMARKET
Economic concerns in the aftermarket have been widely contested. The two main schools of thought that are actively affianced in the debate are the Chicago and post-Chicago schools of thought. The schools figure out whether firms which are present in both primary and secondary market can monopolize in the aftermarket and whether this monopolization can cause a consumer loss.[iv] The Chicago school of thought (“CSOT”) believes that the anti-competitive effects of aftermarket monopolization are almost nil. On the other hand, the post-Chicago school of thought (“PCSOT”) believes that the consumers are being exploited by the monopolization existing in the aftermarket. To understand the stand of both the schools it is relevant to understand their arguments and justifications in detail.
3. CHICAGO SCHOOL OF THOUGHT
The CSOT is more consumer-oriented and believes that competition authorities should only interfere in a market concern if it causes consumer harm. It largely believes that markets are self-correcting and therefore, competition authorities should have minimum say in market structures. Based on this ideology, the Chicago school does not believe that a firm engaged in the primary market can exploit consumerism in the aftermarket by gaining monopoly power for the following reasons:
1. Single Monopoly Profit Theory: The theory asserts that a firm that already enjoys a monopoly and engages in certain exclusionary conduct, cannot harm competition because of the “single monopoly profit”. According to this theory, a firm having a monopoly in the first market cannot gain monopoly profits from the second market by leveraging its position in the first market.[v] This is because a monopolist will already have the incentive and ability to charge a monopolistic price and further, it cannot profitably expand its monopoly power by charging even higher prices.[vi] The CSOT, using this theory, argues that a monopoly in the primary market has no incentive to monopolize in the aftermarket and would rather earn profits in a competitive aftermarket.[vii]
2. Life Cycle Test: The CSOT believes that consumers are rational and hence, capable of making informed choices. They argue that there is sufficient information available to the consumers and thus, they can make an informed choice by keeping in mind the life-cycle cost of a product. The argument assumes that while buying a product the consumers calculate the cost that they will have to incur on the maintenance of that product in the aftermarket.[viii] The consumers are farsighted and will not choose a product that would require high aftermarket cost and therefore they cannot be exploited in the aftermarket.
3. Consumers see primary and aftermarket products as a system: The Chicago school protagonist's bone of contention is that when a consumer buys a product, they see it and its services as one product or as a set of products. Therefore, while buying a product, the consumers look at the total price of the product and not how it is distributed in the primary or secondary market. Hence, an informed consumer can never be exploited in the aftermarket as for him, the price of the services in the aftermarket was always within the total of costs that he would incur in both the primary market and aftermarket. For example, a consumer buying an expensive car would be well aware of the cost of services and spare parts that he will have to incur in the aftermarket during the lifetime of the car.
4. Competition in the primary market will compensate for monopoly prices in the aftermarket: The CSOT argues that competition in the primary market rebates supra-competitive profits earned through monopoly prices in the aftermarket.[ix] Therefore, even when the consumers are not well aware of the life-cycle cost of a product, the manufacturers will not be able to earn supra-competitive profits in the aftermarket as they will have to face high competition in the primary market. Further, to trade in good quality products in a highly competitive primary market, manufacturers have to incur losses, and to maintain the quality, manufacturers recoup those losses in the aftermarket. Therefore, aftermarket monopolization is necessary to provide quality products in the primary market.
5. Pro-competitive justifications of aftermarket monopolization: The CSOT believes that aftermarket monopolization has pro-competitive justifications rather than entailing anti-competitive justifications. The school puts forth the efficiency argument stating that aftermarket monopolization will increase the investment of the manufacturers in the primary market.[x] Especially the increased prices in the aftermarket will allow the manufacturers to bring innovations, creativity, and better products in the primary market. Notably, in absence of the ability to monopolize prices in the secondary market, the firms will offer high prices or lower quality in the primary market.
4. POST- CHICAGO SCHOOL OF THOUGHT
Contrary to the CSOT, the PCSOT believes that there exist sufficient anti-competitive harms of aftermarket monopolization despite the justifications put forth by the Chicago school. The PCSOT questions the arguments of Chicago school on the following points:
1. Installed Base Opportunism: An installed base opportunism is when a consumer has bought the product from the primary market and is, therefore, locked-in with the seller for its aftermarket services. The PCSOT argues that since the consumers are locked-in with the producer in the primary market, the producers can exploit them.[xi] Compatibility of the product with the services provided in the aftermarket and high switching cost for consumers are some of the reasons which allow the producer to exploit the consumers in the aftermarket.[xii]
2. Surprise Theory: Even well-informed and rational consumers cannot always predict the lifetime cost of a product. Further, even if they do so, there are situations when producers change the terms and conditions of the services unilaterally. The PCSOT argues that when consumers are surprised by the unilateral change in policy after buying the product in the primary market, it is difficult for them to switch to another product due to the cost that they have already incurred in the primary market, and thus, they are being exploited.[xiii]
3. Limited Commitment Theory: The PCSOT argues that irrespective of the competition in the primary market, there comes a time when it is beneficial for the producers to exploit their consumers in the aftermarket.[xiv] The theory can be related to a situation where a producer has a greater installed base as compared to new sales. Particularly, the producer’s sales in the primary market are falling as compared to his past sales, and therefore, he has a greater installed base. In this situation, the producer will find it beneficial to exploit consumers in the aftermarket instead of maintaining a reputation in the market.
4. Consumers cannot always make rational choices: Post-Chicago scholars rely on the concept of consumer myopia and believe that a consumer cannot always be aware of the expenses that he is going to incur through the life-cycle of the product.[xv] They argue that there will always be some hidden cost, which the consumers could not see at the time of investing in the primary market. Therefore, it is easier for producers to charge supra-competitive prices from the consumers in such situations.
The approach of both Chicago and post-Chicago though differ on many lines but both of them bottle down to the fact that economic justifications are relevant in understanding the effects of aftermarket monopolization on market competition and consumer welfare.[xvi] These approaches have further been used across various jurisdictions to assess the anti-competitive restraint of aftermarket monopolization.
[i] Shamsher Kataria v. Honda Siel Cars India Ltd., 2014 CompLR 1 (CCI), ¶ 20.5.5.
[ii] Joseph Farrell & Paul Klemperer, Coordination and Lock-in: Competition With Switching Costs and Network Effects, in 3 Handbook of Indus. Org. 1967, 1971 (M. Armstrong & R. Porter ed., 2007).
[iii] Ravi Gangal & Deesha Dalmia, Aftermarket Abuse of Dominance in the Real Estate Sector: Its Analysis and Negative Impact on Consumer Interests 1 Indian Competition Law Review 34, 35 (2016).
[iv] Antonio Capobianco et al., Competition Issues in Aftermarkets, OECD (2017), https://one.oecd.org/document/DAF/COMP(2017)2/en/pdf.
[v] Einer Elhauge, Tying, Bundled Discounts, and the Death of the Single Monopoly Profit Theory, 123 Harvard Law Review (forthcoming Dec. 2009).
[vi] Robert H. Bork, The Antitrust Paradox: A Policy at War with Itself, 13 Val. U.L. Rev. 403, 231 (1979).
[vii]Competition Issues in Aftermarkets - Note from BIAC, OECD (2017), https://one.oecd.org/document/DAF/COMP/WD(2017)51/en/pdf. [viii] Carl Shapiro & David J. Teece, Systems Competition and Aftermarkets: An Economic Analysis of Kodak, 39 Antitrust Bulletin 135 (1994).
[ix] Benjamin Klein, Market Power in Aftermarkets, 17 Managerial & Decision Economics 143 (1996).
[x] Joseph P. Bauer, Antitrust Implications of Aftermarket, 52 Antitrust Bulletin 31 (2007).
[xi] Carl Shapiro, Aftermarkets and Consumer Welfare: Making Sense of Kodak, 63 Antitrust L. J. 483 (1995).
[xii] Joseph Farrell & Carl Shapiro, Optimal Contracts with Lock-in, 1-31 (UC Berkeley Dept. of Econ., Working Paper No. 8758, 1987).
[xiii] Supra note 7.
[xiv] Severin Borenstein et al., Antitrust Policy in Aftermarkets, 63 Antitrust L. J. 455 (1995).
[xv]Supra note 4.