Market Performance Implications of the Transfer Price Rule

The “transfer price rule” (TPR) defines a vertical price squeeze as an input price, output price combination set by a vertically-integrated firm monopoly producer of an essential input that would not allow the firm's downstream unit to earn at least a normal rate of return on investment in the “as-if” case that it had to purchase the input at the price charged independent firms. In its 2009 linkLine decision, the U.S. Supreme Court rejected the TPR for the purpose of enforcing the anti-monopolization prohibition of Section 2 of the Sherman Act. In contrast, a vertical price squeeze, defined by a TPR-like standard, is an abuse of a dominant position under Article 102 of the Treaty on the Functioning of the European Union. In this article, we model the impact of the TPR on market performance. We find that the TPR increases consumer surplus and net social welfare if all firms remain active in the downstream market. It sometimes induces the upstream firm to refuse to supply the downstream firm, and in such cases, consumer surplus and net social welfare are reduced. The impact of the TPR on market performance thus depends on whether or not an upstream firm can refuse to supply downstream firms on terms that would offer it at least a normal rate of return on investment.