Hurting or helping competition? An examination of exclusive dealing contracts in the European automobile industry

Do European car manufacturers make exclusive dealing contracts with their retailers to keep out new, smaller suppliers (mainly from Asia) and in turn, hurt competition? The manufacturing industry could collectively maintain an exclusive dealing system through a block exemption regulation, which would require exclusive dealing through manufacturers’ retailers. Our research shows that if these exclusive contracts were banned, consumers would benefit from allowing dealerships to have more than one supplier and consequently, more brands of cars in stock. However, consumers would not benefit much through increased price competition, in contrast to what is commonly believed.

Exclusive dealing has become prevalent in most European countries, with an average of about 70 percent of European car dealers practicing exclusive contracts.

After a decade of less tolerance, the European Commission has recently decided to again facilitate exclusive dealing contracts in the car market. In such a contract, a car dealership (retailer) engages in an exclusive relationship with a single supplier of a particular brand of cars (e.g., Ford, Volkswagen, etc.), and therefore accepts not to sell brands from competing suppliers. Our research (Nurski and Verboven 2016) provides one of the first empirical analyses on whether exclusive dealing may indeed act as a barrier to entry for new suppliers, and what this implies for consumers and overall welfare. We consider the European car market, which has a long history of industry regulations towards exclusivity contracts and other vertical restraints, i.e., competition restrictions. Since its first Motor Vehicle Block Exemption in 1985, the European Commission accepted that manufacturers could impose exclusive dealing on their retailers. As a result, exclusive dealing has become prevalent in most European countries, with an average of about 70 percent of European car dealers practicing exclusive contracts.

In the past, exclusive dealing was considered to be an anticompetitive entry barrier for new suppliers because upon entering the market, new suppliers are forced to set up their own costly distribution networks among retailers. The Chicago school (e.g., Posner 1976) challenged this view, stressing that the established supplier must pay the retailer to accept an exclusive contract. As a result, an exclusive deal is only in their joint interest if there are efficiencies such as better service provision or reputation. The recent post-Chicago literature, in turn, identified conditions under which an established supplier and a retailer have a joint anticompetitive incentive to establish a contract of exclusive dealing as a way to foreclose entry from competing upstream suppliers (e.g., Aghion and Bolton 1987). The main insight is that such contracts imply unexpected consequences on other players not accounted for by the Chicago school.

Conceptual framework

Consistent with recent post-Chicago theories, our conceptual framework takes as given that established suppliers, or incumbents, can convince their retailers to accept exclusivity, i.e., not to sell any competing brands. We focus instead on the largely ignored question of whether the established suppliers have an incentive to keep out an upstream entrant, or new supplier, in the first place. The theoretical literature has typically taken this for granted, by assuming that upstream entry reduces the incumbent’s and entrant’s joint profits. In practice, however, this is not so obvious. On the one hand, entry through multi-branding in dealerships leads to intensified price competition and it may also reduce demand if consumers value dealer exclusivity (for example, because of improved services or a better perceived reputation). But on the other hand, entry by a new supplier may also increase demand through two channels. First, when an individual incumbent (say, Volkswagen) unilaterally provides access to a new entrant on its distribution network, this steals business from competing incumbents (such as Renault or Ford). If this business stealing effect is important, an incumbent may not have a unilateral incentive for exclusive dealing to deter entry. Second, even when all established suppliers collectively provide access to new entrants on their dealership networks, this may raise total industry demand, because of increased spatial availability, i.e., the ability of dealerships to offer more brands, and the associated benefits from having a variety of products in one location. In sum, while entry through the incumbents’ distribution network may intensify price competition and reduce demand if consumers value exclusivity, it may also raise demand because of business stealing and/or market expansion through increased spatial availability. As a result, new suppliers entering the market may be able to sufficiently compensate established suppliers for not signing exclusive contracts with their retailers.

Our research shows that if these exclusive contracts were banned, consumers would benefit from allowing dealerships to have more than one supplier and consequently, more brands of cars in stock.

This conceptual framework serves as a guide for our empirical analysis of exclusive dealing as an entry barrier in the European car market. We collected a rich dataset on car sales per model at the level of local towns in Belgium, and we combined this with data on dealer locations and consumer demographics. Our empirical analysis consists of two steps: a demand analysis where we study how consumers value exclusive dealer networks—in particular, how consumers value dealer proximity and dealer exclusivity (for both sales and after-sales services, since both are still strongly linked in the European car market)—and a counterfactual analysis where we consider how a hypothetical removal of exclusive dealing contracts would affect profits and welfare.

How do consumers value dealer proximity and exclusivity?

Our empirical demand analysis allows us to study how consumers value differentiated cars, extending the research of Berry, Levinsohn, and Pakes (1995) and other work on the automobile industry. Estimating how consumers value dealer proximity is important because exclusivity implies that consumers have to travel farther to buy cars and receive distribution services. Estimating the value of exclusivity is also important as it enables one to assess whether consumers choose certain brands because of perceived reputation or improved services. In our empirical analysis we are aware of a potential endogeneity issue, or reverse causality, in which dealers may decide to locate in the most profitable areas and exclusivity contracts may especially take place there when they are expected to be profitable. We accounted for this as much as possible by accounting for observed profit determinants across local markets (such as income or demographic composition), and in a sensitivity analysis also through an instrumental variable approach at the local market level, all of which allows us to better understand the causal effects at play.

We find that dealer proximity is an important determinant of automobile demand. This gives a first indication that exclusive dealing may serve as an entry barrier for new suppliers, and that this may result in consumer losses because they have to travel farther for sales and after-sales services. We also find that consumers have a positive average willingness to pay for dealer exclusivity. This suggests that there is also an efficiency rationale for retailers to deal exclusively with suppliers in the form of increased consumer demand.

A shift from exclusive dealing to multi-branding in Europe

We subsequently combine the demand model with a model of oligopoly pricing, to perform a counterfactual analysis of exclusive dealing practices. We focus on the effects of a shift from an industry-wide exclusive dealing system to a system with multi-branding agreements between (European) incumbents and the more recent (Asian) entrants. The counterfactual calculations take into account that there will be a new price equilibrium (i.e., the price at which the quantity of a product offered is equal to the quantity of the product in demand) after the shift to multi-branding. However, the calculations take consumer valuation of the difference between exclusive and non-exclusive dealerships as fixed. In practice, changing investment incentives (for investment in dealer services, etc.) might alter these relative valuations in the new equilibrium, and the current calculations cannot take account of this possibility. Consistent with antitrust and competition policy practice, we consider both the internal profit incentives and the external effects of a shift from exclusive dealing to multi-branding.

Regarding the internal profit incentives, we find that incumbents obtain a strong variable profit increase if they unilaterally shift to multi-branding with recent entrants. Although this reduces demand (because consumers value dealer exclusivity) and also slightly intensifies price competition, multi-branding enables the firms to steal business from other competitors because of increased spatial availability. At the same time, however, we find that incumbents have no collective incentive to shift to multi-branding with entrants. This only creates a small amount of market expansion through increased product differentiation and spatial availability, and this is largely outweighed by a demand drop from the lost value that consumers associate with dealer exclusivity and by losses from intensified competition. Put differently, there is no unilateral profit rationale for the prevalent use of exclusive dealing, but there is a collective rationale for the industry as a whole. These findings may explain the industry’s efforts to organize exclusive dealing under an industry block exemption regulation, as this provides a collective incentive infrastructure for all incumbent firms. This is consistent with the view of Hemphill and Wu (2013), who argue that it is easier to coordinate on simultaneous exclusionary behavior than on collusive prices, both of which limit the market and competition.

Consumers gain from increased spatial coverage when dealers can sell many more brands, as in a supermarket. These gains considerably outweigh the lost value associated with dealer exclusivity.

Regarding the external effects, we find that a collective shift to multi-branding would raise the smaller entrants’ market share. But more importantly, consumers would gain from the removal of exclusive dealing contracts, namely by €105 per household. These gains especially stem from increased spatial availability (+€156 per household), which compensates consumers for the lost value of dealer exclusivity (-€58 per household). There is only a very small gain from increased price competition under multi-branding (+€7 per household). In sum, the prevalent use of exclusive dealing throughout the car industry implies important consumer and welfare losses because of too limited spatial coverage of dealer networks. But it has an insignificant anticompetitive impact, in contrast with what theories have often stressed.

Policy implications

The European Commission has recently decided to facilitate exclusive dealing practices in the car market. Our findings suggest that this decision may not have been warranted. Consumers gain from increased spatial coverage when dealers can sell many more brands, as in a supermarket. These gains considerably outweigh the lost value associated with dealer exclusivity.

Our work also contributes to the policy debate on non-tariff trade barriers. Policymakers in both the United States and in Europe have repeatedly expressed concerns that the reduction of government-imposed trade barriers (here: the long process of European market integration) may induce private companies to set up anticompetitive practices as a protection against foreign manufacturers. In this respect, our findings suggest that exclusive dealing in the European car market has only served as a relatively mild entry barrier against Asian competitors, but with considerable consequences on consumers’ domestic welfare because of the reduced spatial coverage.

Further reading

Aghion, Philippe and Patrick Bolton. 1987. “Contracts as a Barrier to Entry.” American Economic Review 77 (3): 388–401.

Berry, Steve, James Levinsohn and Ariel Pakes. 1995. “Automobile Prices in Market Equilibrium.” Econometrica 63 (4): 841­­–90.

Hemphill, Scott and Tim Wu. 2013. “Parallel Exclusion.” The Yale Law Journal 122 (5): 1182–1253.

Nurski, Laura and Frank Verboven. 2016. “Exclusive Dealing as a Barrier to Entry? Evidence from the Automobile Industry.” Review of Economic Studies, in print.

Posner, Richard. 1976. Antitrust Law: An Economic Perspective. Chicago; University of Chicago Press.