Vertical restraints

Vertical restraints are agreements or concerted practices that define the relationship between two or more companies that are located at different levels of the supply chain (usually between producers and distributors).

Vertical restraints

Vertical restrictions are generally established through contracts that specify the form and conditions in which the parties can buy, sell or resell certain goods or services.

An example of these is an agreement between a wood producer and a carpenter.

Economic justification for vertical restraints

The production or sale of goods and services requires the interaction of different companies: input suppliers with manufacturers, distributors with producers, etc.

The objective of the restrictions is to achieve better coordination between companies, reduce transaction costs, guarantee supply, offer services to customers, among other aspects.

Examples of vertical restraints

Some examples of vertical restraints are:

  • Payment schemes : Such as, for example, franchise payments, loyalty discounts, quantity discounts or royalties, among others.
  • Setting the resale price: Minimum or maximum price, suggested or imposed on the reseller.
  • Minimum quantity : A minimum quantity that must be bought or sold is set.
  • Exclusive distribution: The distributor only works with one supplier or brand.
  • Exclusive territories : The distributor operates only in a certain territory with no other competitors.
  • Tied purchases : The distributor is obliged to buy a set of products from the producer.

Problems that can be solved through vertical restraints

Some problems that can be solved with vertical restraints are:

  • Double marginalization : When both the producer and the distributor have market power, both will impose a margin which will cause the price to be above the optimum. Thus, sales are reduced too much due to the high price.
  • Free Rider : Some distributors take advantage of the sales effort made by others. They let others deliver the services and they cut prices to stay with customers.
  • Risk aversion : Leaving all transaction risk to the seller or distributor can reduce your incentives to participate in a market.

Competitive risks of vertical restraints

Some vertical restraints may raise concern for competition authorities because they tend to limit competition. However, the analysis must be done on a case-by-case basis since, as we have seen, vertical restrictions generate efficiencies that must be contrasted with potential competitive risks.