Antitrust and the Close Look: Transaction Cost Economics in Competition Policy

This paper briefly examines the contributions of Transaction Cost Economics (TCE) to antitrust analysis, focusing on vertical integration and its contractual substitutes, mainly, minimum and maximum resale price maintenance, vertical nonprice restraints, tying, bundled discounts and exclusive dealing and related exclusionary contracts. TCE generally assumes that business firms organize their activities so as to maximize their value, which they can do both by economizing and also by obtaining higher prices. Sensible antitrust policy recognizes that both advantageous contracting and monopoly can be profitable to a firm, and it can be expected to pursue both when they are available. Nevertheless, the opportunities for economizing are many, while those for monopoly are relatively few. Further, firms evaluate alternatives from their present perspective, which necessarily includes the consequences of past decisions. The movement of resources from the current position is costly, and one of these costs is that of relying on the market. One of the first choices firms must make is whether to use internal production or external procurement for a particular input or process. When products and distribution are specialized, many of a firm’s contractual arrangements with others must necessarily be of long term and somewhat open ended, in the sense that they do not anticipate every conceivable circumstance. Product differentiation tends to produce specialization at all levels, and this has two effects. First, it tends to make firms larger vertically, because the cost of internal production is relatively lower and the cost of market procurement relatively higher. Secondly, insofar as a firm uses external procurement its contractual relationships become more durable and more complex because the parties must often make substantial commitments to the technologies and product designs of their trading partners. While all participants are rational, they do not have perfect information and they almost always know more about themselves than about others. A rational firm anticipates that, to the extent uncertainty exists, everyone in the market will try to use new situations to their own advantage, itself included. Transaction cost economics builds on these insights, which determine not only what a firm’s boundaries will be, but also who are likely to be its bargaining partners in outside markets and what those bargains will look like. For example, an exclusivity provision in a contract permits a firm to retain some of the control and disciplinary advantages of internal production, while sharing investment costs and risk