I was watching Ramsey's Kitchen Nightmares, the BBC version, when I was struck by the oddity of a restaurant taking a loan from a brewery. (Actually it was even more odd, as it sounded semi-statist, being "the national brewery", which sounds a bit collectivist for me, but may just be a less than felicitous name) But, a little later, I recalled watching an episode of Life on Mars, again the BBC version, in which the detectives went undercover as replacement bartenders at a pub. Their excuse was that they were sent by the brewery, obviously suggesting pubs are, or at least were, sometimes owned by breweries. It is a logical state of affairs, every bit as much as movie studios owning theaters or car makers owning dealerships, but, in the first two cases, but oddly not the third, it is a situation nearly unknown in the US¹.

Of course the reason is, at its root, a government one. While a few areas, such as car dealerships, Apple stores and a handful of others, have managed to avoid censure, by and large the government is very wary of the oft-denounced "vertical monopoly". For those who have not recently attended a civics or history course, and thus don't recall the landmark cases against Standard Oil (and later movie studios), "vertical monopoly" is the situation in which one company owns some or all firms at every stage of the production process. At least ideally. It is usually opposed to "horizontal monopoly", where one firm owns all or almost all firms at a single stage of production, such as all silver mines, or all retail coffee shops. "Vertical monopoly" does not usually involve any "horizontal monopoly", or does not necessarily involve any, and it also often does not extend, despite the term, all the way up and down the entire production chain². For example, the "vertical monopoly" of the film studios, during the studio system's heyday involved control of studios, distributors, theaters, and control over actors, writers, directors and others through exclusive contracts. However, it did not include ownership of the production of physical film stock, the processing of the same stock, manufacture of film or sound equipment, or many other stages in the process. It was a "vertical monopoly" only in a very limited, almost metaphorical sense.

Obviously, I have written about monopolies before, most fully in "Greed Versus Evil", though also, to some degree in "Bad Economics Part 2", "Bad Economics Part 5 ", "Bad Economics Part 12", "Bad Economics Part 15" and "Bad Economics Part 16", where I denied that a true coercive monopoly is possible in a free market, and, in the unlikely even a talented firm, or unusual circumstances, allowed a non-coercive monopoly to exist, it would, because of the efficiency and responsiveness required to maintain such a non-coercive monopoly, be at least as efficient as the free market would be with multiple competitors, if not better³. And, looked at logically, the arguments against "horizontal monopolies" or monopolies in general would also apply to these "vertical monopolies". If a non-coercive monopoly is harmless at one level of the production chain, clearly it would be harmless as well spread over the same chain.

But that is the logical argument, and in many cases logic pales before emotion. Just as calling a firm "a multinational" or "big business" or calling an investor a "speculator" can taint perfectly acceptable actions in the eyes of some, many find something suspect in vertical integration, even when they do not fear horizontal integration as much⁴. And so, I am going to take a moment to look at vertical integration, vertical monopolies, and, focusing mainly on the question in the title ("who does it harm?"), try to understand what possible harm such integration could do.

The argument usually offered is some variation upon the run of the mill arguments against horizontal monopoly, that vertical integration prevents competition, though in the case of vertical monopoly there is usually more emphasis placed upon the exclusion of competitors. And, on the surface, it may even sound reasonable. Dressed up in the fancy verbiage of economics, it even sounds as if it could happen. For example, if Budweiser were to own bars, they might find it profitable to engage in trade practices which would be against the interests of consumers. Usually the argument takes the form of "While the market would allow them to sell X at a market price of Y, with a closed market, they could sell a smaller amount at a higher price and make more money, while consumers would get less at a higher price."

The problem with such theories is that they ignore the entire market and focus only on a limited subset, which allows such absurdities to exist. For example, assuming we had the fictional Budweiser bars, and they did raise prices due to having a "closed market", would people be so loyal to Budweiser they would pay more? Or would comparable brands continue to charge the lower prices, stealing away a huge share of Budweiser? Yes, there is some brand loyalty, but I think economists often overestimate the power of branding. Not to mention completely overlooking the fact that controlling the distribution of your product is not the same as closing the market entirely.

Perhaps a better example would be the movie studios which owned theaters. Yes, at the time, these theaters controlled a large share of the market, and thus the studios produced a huge percentage of films, but who says that was because of a supposed closed market? Is it not equally possible that the alternative sources of films (such as the "poverty row" studios, and foreign distributors) were producing inferior products? In fact, there is every evidence the market was not closed, as both independent studios and independent theaters, even independent theater chains, existed at the time. Which says the market was not closed, the studios simply dominated by virtue of producing what people wanted. In other words, far from unfairly profiting by charging too much for too little, they were giving the people exactly what they wanted, as shown by the little interest in the alternatives. (Not to mention that it seems bizarre to imagine that movies one could see for pocket change were somehow overpriced.)

Now, there are two other objections (one of which is more commonly applied to the horizontal monopoly than vertical) which are raised against vertical monopolies, both of which can be well illustrated by the studio system. First, that suppliers will be forced into unfavorable agreements by the market power of the monopolist (though, as I said, this is more often an objection to horizontal monopolies, as conceptually vertical monopolies are their own suppliers). The same objection is also often raised in terms of employees, though, technically, employees are nothing but suppliers, suppliers of labor, so there is no distinction. Second, the argument is often made that by vertically integrating an industry, monopolists unfairly exclude independent firms, keeping out competitors, and refusing to sell their products to independent distributors or retailers.

The second is the most bizarre, so let me deal with that first.

Let us start with a hypothetical example. I sell a high-end brand of clothing, very exclusive, sold only in very expensive shops. At some point, Wal-Mart approaches me, asking for the right to sell my clothing in their stores. As I imagine that will do great harm to my reputation, and reduce the value of my brand, I refuse. No one would think that wrong. Similarly, when Apple distributes exclusively through Apple stores, in order to control the quality of their service⁵, no one thinks that wrong.

So, why would it be wrong for a film studio to deal only with certain cinemas they think best for displaying their films? And if those theaters happen to also be the ones they own? Do they not have the right, like any business, to decide with whom they will do business?

The fact is everyone who sells excludes someone when they decide to whom to sell. Whether they do it based on price or other factors is irrelevant. I previously discussed the myth of "economic man" and this is a related fiction. ("Bad Economics Part 16") That being that it is only a legitimate transaction if I base it entirely on concerns of price. If I take into account family relationships, personal affection, race, religion, anything besides price, it is "inefficient". And that simply is not true. For example, hiring my nephew may cost me a few hundred dollars, but the family harmony it buys may be well worth that price to me. Similarly, perhaps the studios find the simplicity of owning the whole distribution chain worth the loss of potential profits from competitive distribution.

Of course, in reality, most vertically integrated systems are relatively efficient, as otherwise they would be driven from the market by competitors. If the big studios produced unwatchable films, or standard oil produced gasoline at $100 a gallon, competitors would have come out of the woodwork, regardless of the suppose "market power" they exercised. And that suggests, as with most antitrust suits, the crime is not so much that the firms were charging too much or harming consumers, but that they were competing too effectively, and were upsetting would be competitors with political pull⁶.

Of course the appeal here is rarely an economic one. Far more often it is the plaintive cry of the failed businessman. "My restaurant would have succeeded, except I couldn't sell that brand of beer", or "since they wouldn't let me distribute their brand, I lost a huge market share." Of course, this ignores the fact that rivals, every bit as excluded from the same distributors, manage to survive. But, it is easier to blame an outsider than admit one's own failing. And, for those who listen, it is easier to commiserate and bash "big business" rather than tell the man in front of you he probably made a mistake.

And from that sort of fuzzy, empathetic thought, we end up with terrible regulation.

Which brings me to the first argument, that of the excluded distributors. Again, this is an absurd argument, as should be obvious from our first discussion. There is no guarantee anyone will buy your products. Unfair as it may be, no one is guaranteed to buy from you. Of course, if you provide a better product at cheaper prices, then those who refuse to buy from you suffer a loss from doing so (and likely at least one will take advantage of the chance, to be able to undercut competition), but there is still no guarantee anyone will buy from you.

But, the truth is, the reason companies engage in vertical integration is not because they wish to exclude efficient suppliers to favor their less efficient firms, they do it, most often, because suppliers were unreliable, unable to provide the type or quantity of goods needed, or otherwise would not meet their requirements. They do not integrate to create new inefficiencies, but to avoid old inefficiencies. Similarly, they do not control the other end of the supply chain, the distribution and sales part, to increase profits. Most often it is intended to either give them more control over the way in which their product is sold, marketed and guaranteed, or, in some cases, to avoid having their product associated with brands, stores, advertisements, or other concepts which they think might damage their reputation. Were the market more efficient, they likely would not vertically integrate. And, should a better supplier or seller come along, it seems likely some, maybe most, would happily allow them into the chain of production.

But, just to show that the myth of the monopoly is fiction in this case, let us look at the studio system once more. Recall the tales of actors tied into contracts to studios, being mistreated through such exclusive agreements? However, what we rarely hear when this example is used, is the way that the big names often avoided such contracts, or managed to renegotiate them when their star rose. In addition, what we also fail to hear is the amount of job security small time actors enjoyed. Yes, it could tie one down in mid-career, when one was not a big star, but big enough that the contractual rate seemed low, but early on it probably worked the other way. As opposed to today, when breaking into the business is difficult, and a handful of roles offers no guarantee of employment, the studio system was simply an alternate way of approaching employment of actors.

But, more important, the studio contract died even before the studios did. Big stars, and stars confident in their abilities, managed to break the old contract system. Not only that, but through novelties such as working for a percentage of net, they managed to create the modern superstar pay of today. All without regulatory intervention. Which suggests that the iron grasp of the studio system, and by extension the grasp of any monopoly, is hardly as powerful as we are told.

And that brings me to my conclusion. Who would it harm? Who would it harm if movie studios owned theaters⁷? If brewers owned bars? If optometrists owned glasses shops? Today car companies own dealerships, computer companies have retail outlets, and there are probably many other examples. But, in some areas of the economy, the exact same practice, or at least a very close analogy, is considered an economic danger.

Why?

Who does a Budweiser owned bar threaten? It puzzles me the amount of worry people feel over such practices.

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1. The laws prohibiting many types of vertical integration, by terming them "vertical monopoly" are a hodgepodge of federal laws, federal regulations, state laws, and court rulings. For example, in some states it is illegal for a optometrist to  have an office attached to a store selling eyeglasses. In others, it is perfectly legal. In addition, thanks to the very vague wording of the Sherman Antitrust Act and its successors, as well as the many regulatory interpretations, court rulings and parallel state laws, it is impossible to determine in some cases whether a given act is legal or not. (See "The Problem With Evolving Standards",  "In Praise of Slow Changes", "Predictability", "Conservatism, Incremental Change and Federalism", "Empathy" Threatens not "Justice" but Predictability", "Sotomayor and Empathy", "Interpretation and Activism", "Why Judicial Activism Hurts",  "The Problem With Tort Reform", "Red Herring", "A True Conservative Platform", "A Perfect Example" and "Analogies For Political Consistency", for my many arguments on the harm done by such uncertain situations.) Thus, it is possible, even likely, that things which I assume are legal or illegal in this post will prove to be the opposite in some states, or even nationwide, at least when you read this. So, if you find such a mistake, take that into account. Still let me know, just understand that the law is a bit less easy to follow in this area than most others.

2. To be honest, a real vertical monopoly would be impossible, as something as simple as a pencil monopoly would involve everything from retailers to wholesalers to pencil makers to graphite mines to those who make graphite mining tools, to those mining steel to make graphite mining tools... As you can see, a thorough-going interpretation of the definition of "vertical monopoly" would actually require something approaching ownership of the entire economy. And thus, despite being a "technical term", vertical monopoly is almost always applied in a metaphorical way.

3. I have described the potential harm of coercive monopolies, as well as their causes in "The Inevitability of Bureaucratic Management in Government Enterprises", "Bureaucracy Revisited ", "The Inherent Disappointment of Authoritarianism", "Transparency, Corruption and Reform", "Put Your Money Where Your Mouth Is, Or The Logical Implications of Price Gouging Laws" and "Capitalism and Its Consequences".

4. To be honest, many otherwise consistent defenders of the free market think there is something special about any "monopoly", and grant the government powers to fight monopolies. They seem to forget that such a step opens the door to many other laws they would find unacceptable (see "Deadly Cynicism", "The Citizen Dichotomy", "In A Nutshell", "Cognitive Dissonance Part 2", "The Right Way", "The Danger Inherent in Banning "Bad Ideas"", "Contradictory World Views" and "Bad Economics Part 12"), but, regardless of the inconsistency, fear of monopolies is very real on the political right, and so it is worthwhile to spend some time trying to bring these individuals to a correct understanding of the free market and the benefits of unregulated competition, even when the results seem to contradict accepted (largely statist) economic theory.

5. It is amusing, because if Apple were not the darling of "free thinkers" and "libertarian leftists" (See "The Failure of Wikipedia", "Copyright as Politics", "Some Libertarian Analogies" and "Revelation From Bottom Feeding"), it would probably be pilloried on the internet, as many of its practices smack of monopoly. From writing operating systems that run only on proprietary hardware (which is sold at a huge markup), to using proprietary file formats, to "integrating" iTunes -- which directs users to their own on-line store -- so strongly into their iPod controls that it is almost impossible to avoid using (similar to the Internet Explorer integration that got Microsoft in so much trouble, especially among Apple fanboys), to the vertical monopoly of Apple stores, to allowing only one carrier for their iPhone, Apple has engaged in practices that would have the internet geekosphere up in arms had any other company done it. Not that I claim there is anything wrong with any of these practices, jut pointing out the double standard applied to Apple, as opposed to any other software company.

6. See "Anti-Business Businesses" for more on a similar topic. Of course, the complaints did not always emerge from would be, or actual competitors, many also arose from federal prosecutors looking to make a name. Think Elliot Spitzer. The fact that one makes a name in politics by "taking down a big guy" should, in itself, make us wary of giving the government the power to regulate economic matters. After all, if the route to public office is destroying the largest, best known companies, does that not suggest a horrible drain on the economy, with no matching benefit?

7. Actually, studio owned theaters never completely vanished. United Artist owns theaters, and there may be others. However, that actually fits well with my overall theme. It would be bad enough if antitrust laws were applied consistently, but in most cases they are applied on a case by case basis, with identical situations producing different results. Even worse, in many cases, the government does not actually prosecute, but instead simply suggests, or intimidates, companies into compliance, making it seem voluntary. Or else prohibit mergers. (By the way, who gave the government the right to allow or disallow mergers?)  And, in many cases, the government does nothing, but antitrust worries lead to companies imposing upon themselves restrictions more stringent than the government would, so as to avoid potential prosecution. So the fact that some cases I have mentioned were not completely regulated, or were not the result of explicit government action does not invalidate my point.

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POSTSCRIPT

I actually managed to avoid writing longer than I expected. And, as expected, despite my promise in the last post, my first item is not one of the posts I promised in "Upcoming Posts", "More Upcoming Posts" or "Two More Posts". I will write them, really I will, but as always, I find myself strangely unable to write a promised post immediately after promising to write it.

POSTSCRIPT II

I am aware that a lot of the examples I have used were either not explicitly prosecuted or were the result of a number of smaller cases. Excepting Standard Oil, there are not a lot of high profile vertical monopoly cases, not like the high profile names attached to traditional horizontal monopolies -- ALCOA, General Electric, Microsoft, and more. Still, much of government antitrust regulation is done, not through regulation or prosecution, but through suggestion, implication and threat. So, just because there were fewer high profile cases it does not mean there was less pressure. In addition to which -- as I discovered when preparing for moot court -- there exist countless causes of private action for monopoly, making it financially risky to do anything which could be even vaguely construed as monopolistic. Which is why I have said several times, even without explicit action, the government still lies at the bottom of many of these actions, whether they appear voluntary or not, as the uncertainty of antitrust laws make it dangerous to engage in certain activities, even when you believe you are in the right.