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The Economics of Gasoline Retailing

Petroleum Distribution and Retailing Issues in the U.S.
Andrew N. Kleit, P.h.D. Professor of Energy and Environmental Economics The Pennsylvania State University

December 2003

Cover Photo Credits

Background photo courtesy of BP p.l.c.

Photo 1: Photo courtesy of ConocoPhillips.

Photo 2: Photo courtesy of ConocoPhillips.

Photo 3: Photo by Corbis

Photo 4: Photo courtesy of Exxon Mobil Corporation.

The Economics of Gasoline Retailing:
Petroleum Distribution and Retailing Issues in the U.S.

Andrew N. Kleit, P.h.D. Professor of Energy and Environmental Economics The Pennsylvania State University ANK1@psu.edu 814-865-0711 December 2003

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5 . gasoline marketing sector is marked by a high degree of competition. for example. Among them. Thus. Refiners use a variety of distribution methods and channels to bring gasoline to consumers in order to compete in this marketplace. however. critics periodically call for the elimination of some of these marketing strategies and practices. This competition promotes efficiency. Similarly. can come into conflict with each other when they coexist in the same marketplace.Abstract The U. own and operate the retail outlets themselves (companyoperated outlets). They can. These marketing strategies.S.” The analysis done in this paper by Professor Kleit.” a person or firm who gains the right to franchise the brand in a particular area. These strategies are the result of competition between various forms of distribution in gasoline marketing. from a competitive viewpoint and a consumer perspective. As a consequence. Kleit finds that eliminating the ability of refiners to restrict where their brand can be distributed would likely reduce their investments in distribution outlets and harm consumers. critics claim refiner restrictions on where jobbers can sell branded gasoline (referred to as “non-price vertical restraints”) reduces competition. This is the practice whereby refiners set uniform wholesale prices and supply branded gasoline directly to their company-operated and franchised dealer stations within a small but distinct geographic area called a “price zone. or they can use a “jobber. shows that these criticisms are not valid. which benefits consumers by bringing product to market for less. Refiners have also been criticized for zone pricing. with their different levels of control and investment by refiners and associated pricing practices. His review of the available theoretical and applied research shows that the elimination of zone pricing would result in higher average prices for consumers. or they can franchise the outlet to an independent dealer and directly supply it with gasoline. Kleit finds that calls for the elimination of non-price vertical restraints and zone pricing in the gasoline marketing sector are misplaced.

D. its member firms. Bureau of Competition. He has a PH.About the Author Andrew N. This research was supported by a grant from the American Petroleum Institute. and not necessarily those of API. in Economics from Yale University. or the Pennsylvania State University. Economic Advisor to the Director. 6 . Previously he had been Senior Economic Adviser to the Director for Investigation and Research. He has published over 40 articles on antitrust and regulatory issues in a wide variety of academic and popular outlets. (The chief antitrust official in Canada). and Associate Professor of Economics at Louisiana State University. Professor Kleit has been named as one of the top competition economists in the world three times by Global Competition Review magazine of London. The views expressed herein are solely those of the author. Federal Trade Commission. Kleit is Professor of Energy and Environmental Economics and MICASU Faculty Fellow at the Pennsylvania State University.

The Rise of Hypermarkets V. Issues Surrounding Non-Price Vertical Restraints The Motivation for Non-Price Vertical Restraints Antitrust and Non-Price Vertical Restraints 24 24 20 21 24 VII. Introduction II.Table of Contents Executive Summary I. Types of Branded Retail Outlets Company Operated Outlets Franchised Dealer Outlets 16 17 18 15 Jobber Operated or Jobber Franchised Outlets IV. Gross Gasoline Marketing Margins Conclusions References 26 27 28 31 7 . The Integrated Refiner’s Problem The Refiner’s Point of View Managing the Brand 13 11 7 10 11 III. Whose Interests Are Being Served? VIII. Issues Surrounding Zone Pricing VI.

page 12 Figure 3: Gasoline Distribution System. Refineries. 1947-2002. page 15 Figure 4: Motor Gasoline Sales by Outlet Type. page 27 8 .Figure List Figure 1: U.S. page 21 Figure 6: Gross Gasoline Marketing Margins. page 16 Figure 5: Theoretical Competitive Zone Development. page 11 Figure 2: Number of Gasoline Service Stations. 1983-2002.

the more efficient the distribution system. The jobber also has incentives for entrepreneurship.” a person or firm who gains the right to franchise the brand in a particular area. The number of retail outlets has declined from over 203. The remaining sites are independently operated and unbranded. and thus protect its brand against “free-riding” that could occur with an independent dealer or distributor. In part. however. The disadvantages of this method include that the refiner gives up a degree of control of the outlet's ability to meet consumer needs. In 2002. A refinery is an expensive investment and is complex to operate. will ultimately depend upon the marketplace forces of supply and demand and competition. integrated refiners accounted for about 78 percent of all refineries in the United States. Lessee and open dealers contribute about 27 percent of the market. there has also been a large decrease in the number of retail gasoline outlets. with about 44 percent of the market.S. refineries has grown. The lower . the retail price of gasoline to consumers. and include the new retailing concept of hypermarkets. These different distribution methods can come into conflict with each other. integrated refiners can own and operate the retail outlets themselves (company owned outlets). this controversy occurs because integrated refining companies use a variety of distribution methods to maximize their efficiencies while moving gasoline from the refiner to the consumer. The goal of this study is to examine why integrated refiners use different distribution methods. the lower the cost of gasoline distribution. Lower distribution costs help drive retail prices lower. The basic advantage of a company operated outlet is that the company can manage the entire customer offering.3 percent in 1992. the chief advantage of a franchised dealer outlet is that the operator has incentives to engage in entrepreneurship. The price of gasoline at the pump. thus leading to potential “free riding” on the refiner’s brand name. how those methods are manifested in retailing and pricing of petroleum products.Executive Summary Introduction The U. the more consumers are likely to drive and the higher the demand for gasoline. It is doubtful that any new refinery could be built in the U. 9 The Integrated Refiner’s Problem An integrated refiner both owns a refinery. Simply put. and the important policy issues that surround those distribution and retailing choices. down from 79. S.000 in 2003. the major advantage of the jobber form of distribution is reduced refiner involvement.S. Refiners have clear incentives to improve product distribution and those incentives work to the benefit of the consumer. The jobber is responsible for siting and building facilities and creating local promotion. First. all else being equal. While there has been a dramatic decrease in the number of refineries. Jobbers constitute the largest fraction of sales.000 in 1994 to about 168. The major disadvantage of this form of retailing is that it is difficult for the refiner to manage the brand it has licensed to the jobber. Despite this. Types of Branded Retail Outlets Companies have three different basic types of outlet options and may employ any or all in their marketing strategies to compete in the marketplace. Comparatively. as the remaining refineries have expanded. The second option is to franchise the outlet to an independent dealer and directly supply it with gasoline. petroleum retailing industry is one of the most competitive in the world. while company-owned operations constitute about 12 percent of the market. at present for a variety of economic and political reasons. The third option is to utilize a “jobber. the capacity at U. which may result in more efficient stations than would occur through company operations. including the retail price of gasoline to the consumer. industry practices in gasoline retailing continue to be controversial. Along with the drop in the number of refineries. and has a branded presence in the retail gasoline market. Finally.

efficiency rationales. and that any anticompetitive resulting behavior must outweigh any efficiency. could result in failure of some sites. under the antitrust laws.” Differences in wholesale prices among price zones in a particular region can reach up to several cents per gallon. implicitly support hypermarketers. These include the competitive conditions in a station’s trading area. such as hypermarkets. It should be noted that price zones are the consequences of different levels of competition in different areas. and the refiner’s traditional outlets. the existence of hypermarkets has generated tension in the relationship between integrated refiners. have recently drawn scrutiny. it must show a logical theory of consumer injury. Refiners seek to support their direct service operators and jobbers. zone pricing becomes a mechanism designed to help dealers compete and respond to new marketing challenges. Indeed. 10 . They recoup these investments through wholesale margins. and the wholesale price to be charged in that zone. Non-price vertical restraints can have important. In particular. and thus affect the overall level of competition in the gasoline retailing sector. Price zones are not the cause of the competitiveness of such locations. who supply hypermarkets with at least part of their gasoline. and typically.” This rule implies that for a plaintiff to succeed in such a case. in turn. by maintaining and improving their competitiveness. based on a variety of factors. In general. This. however. This creates competitive tensions between these two types of outlets. as well as the physical nature of the zone based on natural and artificial impediments to consumers’ purchases. Refiners invest in a variety of promotional and other activities for franchised dealers. the retailing strategy for hypermarkets is to attract customers to their stores through a low price of gasoline and a large number of gasoline pumps. and then induce those customers to come inside their stores and buy other products. though most price differences are much smaller. to keep them in business. the price difference between neighboring stations is minimal. Not surprisingly. Each refiner determines the nature of its price zones. pro-consumer. Refiners also. asserts that non-price vertical restraints should be eliminated to enhance what is referred to as “intrabrand competition. The jobber trade group. and that the balance of the evidence supports that theory. eliminating price zones could result in some retailers being unable to compete. Since the 1977 Sylvania decision. With the introduction of more non-traditional retailers. Non-price Vertical Restraints Non-price vertical restraints in gasoline retailing.The Rise of Hypermarkets Hypermarkets and “super convenience stores” are non-traditional retail outlets that specialize in selling high volumes of gasoline at prices near the wholesale price of gasoline. the Petroleum Marketers Association of America. non-price vertical restraints have been evaluated under the standard of “rule of reason. Thus. and whose stations can be an important distribution channel for refiners. however. refiners generally make more investments in franchised dealer outlets than they do in jobber stations. the available empirical evidence indicates that the abolition of zone pricing would raise the average consumer price of gasoline.” However. the Zone Pricing The FTC has described zone pricing as “the practice whereby refiners set uniform wholesale prices and supply branded gasoline directly to their company-operated and franchised dealer stations within a small but distinct geographic area called a 'price zone'. franchised dealers and jobbers. whose aggressive pricing increases the demand for refined gasoline. Firms look at competitors’ prices in the area when setting up their own zones. in the form of restrictions on where jobbers can sell branded gasoline.

Given this. from $0. is to protect the interests of the consuming public. It appears. refiners use nonprice vertical restraints with their downstream affiliates. however. Indeed. The analysis of this paper. The retail gasoline marketplace is subject to a wide variety of competitive forces.252 in 1985 to $0.197 per gallon in 2002. Gross Gasoline Marketing Margins The best way of analyzing the gasoline marketing sector is by the extent of margins in the sector. 11 . from 1983. The lower the margins.203 in 2002. the lower prices are to consumers. These figures are indications that competition in this area has acted to serve consumers alike. a drop of 29 percent. Several parties have criticized the use of non-price vertical restraints and zone pricing. a decline of 19 percent. research has shown that the elimination of zone pricing would result in higher average prices for consumers. The gross marketing margins for gasoline in the U. It is not to increase the profits of any level or type of distribution. To alleviate these tensions. These and other charges against the retail gasoline distribution network often come from competitors of refiner affiliated stations. Eliminating the ability of refiners to use such restraints would likely reduce their investments in distribution outlets and harm consumers. and generate incentives for the proper level of investment. The strategies at issue are the result of competition between various forms of distribution in gasoline marketing. claiming that they reduce competition in various markets. No coherent anticompetitive theory of the relevant non-price vertical restraints exists. it may be more accurate to examine marketing margins by using three year moving averages.S. The refiner has the same incentive as the consumer of gasoline – to minimize the distribution costs of the product. in constant 2003 dollars. different firms will adopt one or more of several different types of distribution systems. however. It would also force many refiners to exit from more competitive retail markets. From a competitive viewpoint. the purpose of the antitrust laws. these calls are misguided. we observe that margins fell an average of 5 cents per gallon.choice of whether or not to allow “intrabrand” competition should be left solely to the refiner. Refiners also use zone pricing to meet competitive threats in different markets. however. between these distribution systems. when they coexist in the same marketplace. However. These economic actors often have interests that are contrary to both the refiners and the final consumer. Conclusions Critics of the retail gasoline sector have called for the abolishment of non-price vertical restraints and zone pricing in this industry. that margins fluctuate when measured on a yearly basis. shows that these critiques are not valid. Tensions can arise. however. Similarly. In response to their needs in the marketplace. have declined 8 cents per gallon. To eliminate these practices would be harmful to the consuming public. from $0. Employing this metric. with their different levels of control and investment by refiners. and public policy in general.277 per gallon in 1983 to $0. opponents of such restraints admit that these restraints are unlikely to violate the antitrust laws.

Section IV examines the rise of a new “non-traditional” component of this distribution mechanism. In part. Section VII reviews the economic incentives that may cause the opposition to nonprice vertical restraints. Despite a clear record of performance. gross marketing margins have fallen significantly. S. and jobbers. The best way to evaluate the performance of the retail gasoline distribution system is to look at what retailing costs consumers. The goal of this study is to examine why integrated refiners use different distribution methods.Introduction The U. In large part. Since 1983. The refiner also wants to manage its brands so that they can provide benefits to consumers. As long as different types of distribution systems exist. These different distribution methods can come into conflict with each other. how those methods are manifested in retailing and pricing of petroleum products and the important policy issues that surround those distribution and retailing choices. The most controversial practices in gasoline retailing. Section III reviews the three basic methods by which integrated refiners distribute gasoline: through company operated stations. 12 . this controversy occurs because integrated refining companies use a variety of distribution methods to maximize their efficiencies while moving their gasoline from the refiner to the consumer. Like consumers. implying this is an innovative dynamic sector. price zones and non-price vertical restraints. franchised dealer stations. are examined in Sections V and VI. hypermarkets. Section II of this report suggests that events in this sector are best examined from the view of the integrated refiner. integrated refiners will act to optimize their distribution networks and activities like zone pricing and non-price vertical restraints are part of that optimization. The evidence is clear that these practices do not harm consumers. Section VIII examines marketing margins. petroleum retailing industry is one of the most competitive in the world. Section IX contains some concluding thoughts. inconsistent with widespread anticompetitive behavior. the measure of the costs of marketing to consumers. industry practices in gasoline retailing continue to be controversial. the practices of zone pricing and non-price vertical restraints are ways for companies to be competitive in the marketplace while minimizing tensions between distribution channels. such as territorial restrictions. the integrated refiner wants to lower the costs of distributing gasoline.

In addition. Refineries. 1978. Shell. an integrated refiner operates both refineries and retail distribution systems. refiners need to take actions to protect their sunk investments. The Refiner’s Point of View The best way to examine the retail distribution of gasoline is from the integrated refiner’s point of view.3 percent in 1992. Sun Oil (Sunoco) and ChevronTexaco are integrated refiners. 1947–2002 1 Data derived from National Petroleum News Factbooks and U. it is very difficult to enter into the refining business.) Sunk investments are considered risky by economists. Figure 1 U. Of course. Thus. In 2002. many observers state that it is impossible to build a new refinery in the United States. (See Klein. and has a branded presence in the retail gasoline market.S. refinery investments cannot be switched into another sector should the refinery prove non-remunerative.S.1 In this context. BP. Such firms as ExxonMobil. Petroleum Supply Annuals. Energy Information Administration. 13 . An integrated refiner both owns a refinery. Marathon Ashland. The last new refineries in the United States went onstream in the late-1970’s. From an economic point of view. there are refiners without a retail presence. The Integrated Refiner’s Problem A. and Alchian. down from 79. as well as independent gasoline stations and chains that do not own refineries. Crawford. Thus.II. Indeed. A refinery is an expensive investment and is complex to operate. integrated refiners accounted for about 78 percent of all refineries in the United States. since they do not have valuable alternative uses. it also represents a “sunk” or “asset specific” investment.

Gasoline retailing requires investments primarily in land and storefronts. aging facilities and other physical constraints.) Since 1947. and changes in the nature of ancillary business.S. (Unfortunately. there has been a dramatic decrease in the number of refineries. population dynamics. breakdowns by type are not available.S. including the cost of compliance with environmental regulations. Such assets are relatively easy to obtain. such as automotive repair work. the number of refineries has declined from 399 to 149.Over time in the U.) This decline in the number of stations has been the result of a number of factors.000 in 2003. The gasoline retailing sector is entirely different than the refining sector with respect to asset-specific investments. Also. resulting in a tripling of total refining capacity from 5 million barrels per day to over 16 million barrels per day. retail margins have compressed over the years.000 in 1994 to about 168. the amount of capacity at U. the number of outlets has declined from over 203. However. As Figure 2 indicates. the refinery average capacity has grown significantly. as the remaining refineries have expanded their capacities. therefore. There is. a great deal of entry and exit in this sector. and relatively easy to move to alternative uses. There has also been a substantial decrease in the number of retail gasoline outlets. refineries has grown. (See Figure 1. Lower margins require higher volumes and some stations have simply been incapable of producing the throughputs necessary to remain viable due to small properties.. Figure 2 Number of Gasoline Service Stations 14 . At the same time.

The price of gasoline at the pump. to a terminal. Managing the Brand In addition to seeking out the lowest cost methods of distribution. all other things being equal. and the quality of these packages is one measure upon which retail gasoline stations compete. refiners have exactly the same desires as consumers. The lower the retail price of gasoline to consumers. most refineries produce “base gasoline” that meet Federal standards. A refiner also desires a more certain market for its product than would be available simply by using gasoline “spot markets. Thus. The higher refinery prices. all else being equal. or “rack. the value of a brand is represented by the amount consumers are willing to pay producers for an implicit promise of value. the more efficient the distribution system. however. however. a refiner desires to get its product to market – from the refinery. however. Today. the higher the wholesale price (at the refinery) of gasoline. the more consumers are likely to drive and the higher the demand for gasoline. A natural candidate for the use of branding is gasoline.) In economic terms. the lower the cost of gasoline distribution. The first input into establishing a brand is selling quality products and services for a substantial period of time. both integrated and nonintegrated refiners desire low distribution costs for gasoline. It is very important to understand that the refiner has clear incentives to improve product distribution and that those incentives work to the benefit of the consumer. all else being equal. through a pipeline or other method of transportation. than the investment in other marketing and distribution assets. 15 . and then sold to a customer. the higher the demand for gasoline. in general. whose attributes are not clear to the eye of the consuming public. and more at risk. the higher refinery profits. this paper is about the retail distribution choices integrated refiners must make if they are to remain viable. Klein and Leffler. as it increases their refining profit potential. That expectation is reinforced by advertising. At the refinery. who desire low costs of retail distribution to create low retail gasoline prices for consumers across all types of retail outlets. A perhaps less obvious candidate for branding. The utility of branding is often unclear to casual observers. B. In the case of integrated 2 Naturally. A station’s brand logo signals to the consumer the quality of these goods and services. Thus. The basic theory of establishing a brand reputation is clear.” This task. Lower distribution costs help drive retail prices lower. 1981.” firms add in their own package of additives. The refining of oil is of little value if there is not an efficient method to market the product. for example. the refiner often has an important name brand reputation to both employ and protect. 1983.2 In large part. refiners also seek to earn an adequate return on their marketing and distribution assets as well. building up a positive expectation in the minds of consumers about quality. At the “rack. refiners will seek the most efficient and lowest cost set of distribution methods. have conducted important work in this area showing how branding serves to protect product quality for consumers. will ultimately depend upon the marketplace forces of supply and demand and competition. In that sense. is extremely complex.It is thus the refining sector where investment is most at risk. is the quality of other goods and services at gasoline outlets. The quality of these services is by no means apparent when a consumer chooses a particular station. (See. Each firm’s package has different attributes. Simply put. The promise of value deals with goods whose quality is not obvious upon inspection. But their investment in refining is generally far greater. which serves to signal that the high quality products will continue to be supplied. but still quite important. The branding of a product also implies product consistency – that the product will have the same quality each and every time it is purchased by the consumer. and Shapiro.” via truck to a station. As the discussion above indicates. and the conflicts between the resulting distribution channels. Economists.

as well as the integrated refiner.3 This aspect of brand quality. and claims that its gasoline is significantly superior to other brands of gasoline. so the refiner seeks to keep station prices at competitive levels. 2000. the differential in quality between their own gas and other brands is quite small. High price levels at one outlet harm the refiner’s brand name identity. their brands are the result of decades of providing high quality service. 1999. offered at retail outlets.” the end of the pipeline or supply line from the refinery. In the retail gasoline sector. the refiner depends in large part on independent dealers to present its brand image to the consuming public. however. Once a refiner has established a brand name reputation. (See. In the gasoline sector. and whether or not the retail fuel price is above competitive levels. is relatively straightforward to protect. Outlets are monitored closely for the quantities of gasoline they order from the refinery.refiners. Another aspect of brand quality is the nature of the other. Because a reduction in quality has the effect of reducing the demand facing all franchisees using the common name. Bai and Tao. Outlets are required to sell only gasoline from a specific brand. it must take active measures to manage that reputation. Especially important in this category is the cleanliness of station facilities. non-gasoline services. there are two important aspects to brand name. It is this type of shirking that brand management seeks to stop. resulting in reduced profits for other outlets. the refiners hire testing services to determine if the gasoline at an outlet’s pump is actually that brand’s gasoline. each franchisee can reduce its costs by reducing the quality of the product it supplies without bearing the full consequences of doing so. Each integrated refiner has a special package of additives that it adds to its gasoline at the “rack. 3 16 Of course. quality of other products sold at the station. this action harms the brand name value of the entire chain. For example.) The integrated refiner must take active steps to stop its franchisees from “free-riding” on its reputation. The first is the quality of the brand’s gasoline. as discussed below in Section IV. established brands face new challenges from “superconvenience stores” and hypermarkets. In such circumstances. Other items of concern involve station hours. The perception of this quality varies from firm to firm. Klein (1995 at 12-13) describes the problem this way: In general. Today. However. she will see a distinctive sign with a particular refiner’s brand name on it. the incentive for individual franchisees to supply the desired level of quality is reduced. when a potential consumer is driving down the road looking for a gasoline station. for example.) Integrated refiners spend substantial resources in hiring monitoring services to evaluate stations on these criteria. backed up by large national advertising campaigns. while quality of gas is important. . (See also the discussion below in Section III-B. 1998. This may increase the outlet’s profits by reducing its costs. The quality that brand signals will help the consumer decide whether or not to go to that station. But that brand quality is shared among the brand’s outlets. the attributes of the gasoline sold. this type of disagreement among competing firms in the industry is to be expected. Failure to sell only the specified brand of gasoline is cause for franchise termination. For example. it could be profitable for the owner of a particular outlet to “shirk” on product quality – not offer the product or service quality implied by its brand name. one integrated refiner makes the quality of its branded gasoline a centerpiece of its marketing campaign. Lafontaine and Shaw. when franchisees use a common brand name. not just the future demand facing the individual franchisee who has reduced quality. In addition. Hart and Murphy. Other firms assert that.

jobbers constituted the largest fraction of sales. In this section I will review the advantages and disadvantages of each type of outlet from the refiner’s point of view. called dealers. This option may have three different forms of property ownership. Different refiners. they can own and operate the retail outlets themselves (company owned and operated outlets). The remaining sites are independently operated and unbranded and include the new retailing concept of hypermarkets. depending on which type is perceived as most efficient. The second option is to franchise the outlet to an independent dealer and directly supply it with gasoline. with about 44 percent of the market. as well as to independent gasoline retailers. Figure 4 gives the breakdown of sales by type of outlet since 1995. Companies have three different basic types of outlet options and may employ any or all in their marketing strategies to maximize efficiencies and compete in the marketplace. while company-owned operations constitute about 12 percent of the market. The mix of distribution methods varies widely across firms. A diagram depicting the different types of retail outlets is shown as Figure 3.” who gains the right to franchise the brand in a particular area. and distributors. as depicted in Figure 3. The third option is to utilize a “jobber.III. lease from a third party. In 2001. First. In addition. use different types of outlets. Lessee and open dealers contribute a little over 27 percent of the market. Types of Branded Retail Outlets Integrated refiners sell gasoline through their own company operated outlets. Figure 3 Gasoline Distribution System 4 The definition of some of these terms can vary across companies. 15 .4 Jobbers may choose to operate some of their outlets with their own employees and franchise other outlets to dealers. This operator can lease from the refiner. some integrated refiners also supply some of the gasoline sold through hypermarkets. often referred to as jobbers. or own the outlet outright.

if a refiner wishes to have a companywide campaign of discounted soft drinks at its outlets. with their own employees. The refiner. a refiner might be interested in investigating a new method of processing transactions.5 It can also ensure that the outlet takes part in the company’s promotional activities. Lafontaine and Shaw (2001). . the refiner could easily try it out at its own stations. For example. company employees generally manage the outlet. Further. a company-operated station also allows the refiner to engage in controlled product or service experimentation. In these locations. for instance. but gives an independent contract manager the opportunity to Figure 4 Motor Gasoline Sales by Outlet Type 18 5 These theories imply that the stronger the value of a refiner’s brand name. For example. It can make sure that only its gasoline is sold at the outlet. To determine (at minimum cost) whether or not the method is feasible. The basic advantage of a company-operated outlet is that the company can manage the entire customer offering. At least one integrated refiner is revitalizing an older “hybrid” method of managing company owned operations by using contract managers at some of its outlets. Company Operated Outlets Most integrated refiners directly own and operate. can select the outlet’s level of service and offerings to best match its perception of local demand. including the retail price of gasoline to the consumer. the more the company owned operations will choose it. taking retailing and pricing direction from the refiner. (often. the refiner owns the station. between 10 and 20 percent) some of their own gasoline outlets.A. Company-operated stations also provide the refiner with immediate and direct access to information about consumer needs and other trends in the marketplace. Under this governance structure. it is much easier to implement that cam- paign at company-owned operations than at independent dealer and jobber outlets. in a study of franchising across products. found this to be the case.

refiners do not want direct service outlets to price uncompetitively.. inducing gasoline sales generates a more certain market for their refined product. For all gasoline sales above 125. either by paying for improvements in the outlet. leases it from the refiner. if refiners own or lease the station property. trol of the outlet's ability to meet consumer needs. Senator Carl Levin of Michigan. In addition. A second form of gasoline outlet is referred to as a franchise dealer. in large part. the refiner may provide the retailer with an incentive to sell more gasoline through rebates designed to reduce the franchised dealer's cost of product. An example of a portion of a “synthesized” contract is presented here. the franchised dealer is able to be more competitive and is encouraged to sell more gasoline. the next delivery of gas from the oil company will reflect any increase instituted by the dealer. If the dealer owns the outlet. Indeed. the refiner may also have invested in the site. in the wholesale price of gasoline charged to the franchised dealer. or.S. at least to some degree. as well as for delivering the product to the station.000 gallons of gasoline per month at the “standard” dealer tankwagon price. it has often invested two or more million dollars in the site. The franchised dealer agrees to buy its gasoline entirely (or almost entirely) from the refiner. which is. the refiner will reduce the price by 4 cents below standard price. The refiner establishes the retail price of the gasoline and other products. Franchised Dealer Outlets While refiners operate some of their own branded outlets. the purpose of vertical integration in this area. The chief advantage of a franchised dealer outlet is that the operator has incentives to engage in entrepreneurship. In such operations the dealer either owns a site outright. as well as other franchised dealers in the chain. The contract manager is responsible for managing the outlet and is paid by commissions on sales. These dealers are saying that if they decide 19 B. For example. Finally. If the refiner develops a new outlet. The disadvantages of this method include that the refiner gives up a degree of con- .000 gallons per month. elaborating on a 2002 U. often at favorable terms or amortized over the term of the contract. the Majority Staff was told by several dealers that if they don’t charge their retail customers the recommended price. Second. they also take the responsibility for environmental liability and major equipment and building maintenance for the site. Senate staff report.000 gallons. In this manner. First. the refiner will reduce the price by 2 cents below standard price. while employing the entrepreneurial skills and community affiliation of the contract manager for the integrated refiner.actually operate the outlet. The cost of these activities by the refiner is reflected. most outlets are operated by others. They have two important reasons for doing so. Refiners who use franchised dealer operations strive to increase the quantity of gasoline sold at franchised dealer outlets. either in the form of the quality of the services offered or the competitiveness of the retail price displayed at the pump. in areas where competitive market conditions dictate.. which is generally a significant obligation. if the outlet purchased between 100.000 and 125. Such an arrangement can provide control of the product and service offerings. or loaning money to the dealer. as that harms the refiner’s brand name. as well as sets service standards. A refiner may agree to supply an outlet with 100. more commonly. and the refiner arranges for the gasoline to be delivered to the outlet. Further. described one alleged incident: . some refiners may also be responsible for securing the site and arranging for promotion of the brand name in the relevant area. refiners may have several other methods they can use to induce dealers to lower prices to consumers. Volume related contractual provisions differ from company to company.

it harms the refiner’s general reputation for competitiveness.will have a 5 cent/gallon increase in the price to the retailer. Hearings on “Gas Prices: How Are They Really Set?. at least on a per unit basis. Minimum volume clauses in the franchised dealers contract require the dealer to sell a certain quality of gasoline per unit of time. reducing refiner profits. Instead. U. it puts the refiner’s investment in the franchised dealer’s outlet at risk.S. the refiner’s interest is in getting a lower price to consumers “on the street. The refiner expects jobbers to develop markets for the refiner’s brand. the refiner may waive these provisions in periods where market demand has decreased for other reasons. Developing markets includes learning about the relevant area. The jobber also has incentives for entrepreneurship. to increase profit. April 30. or face loss of the franchise. Consider a franchised dealer who suffers some type of financial setback. the next delivery of gasoline to the station . and low volume and low profits.” While there are advantages to operating through franchised dealers.6 Whether true or false. these allegations present an interesting example of how a refiner could act in the consumer interest by encouraging lower retail prices from station operators. it reduces the amount of gasoline sold by the refiner through this particular location. smaller franchised dealer operations may be prone to try to increase their unit margins at the expense of volume. This is often a self-defeating strategy. However. The jobber is responsible for siting and building facilities and creating local promotion. 20 . referred to in the industry as the “death spiral. Jobber Operated or Jobber Franchised Outlets A third type of retail outlet is referred to as a “jobber” or a “distributor. or sometimes has its own franchisees operating a portion of those outlets. As the marketing margins continue to decrease (see Section VIII below).” A jobber or distributor is an independent operator who owns and operates a number of retail outlets.. a potentially significant disadvantage is that certain franchised dealers may have limited access to financial resources and working capital. The station operator may go out of business. The station operator may then raise prices again. Senate. To try to solve such problems some refiners will place volume requirements on their dealers. However. c. The jobber enters into an agreement with the refiner to sell that refiner’s gasoline and display that refiner’s brand at particular stations. and finding outlet operators 6 Statement of Senator Carl Levin.” is very adverse to the interests of the integrated refiner.35. Often the jobber has knowledge of local conditions and thus is better able to perform these tasks. 2002 at 9. Third. in an attempt to overcome the setback. Clearly. First. or use other contractual mechanisms discussed above to encourage lower prices. which may result in more efficient stations than would occur through company operations. Second. investigating potential outlet sites. This operator may not have the financial and operating capacity to compete in the marketplace. such an operator may raise its price of gasoline above the market level. even when those operators seek to maximize their margins and profit by charging higher prices. The pattern repeats itself until the point at which the station operator has very high prices.” Permanent Subcommittee of Investigations of the Committee on Governmental Affairs.40/gallon when the oil company recommend $1. The result: station profits will dwindle.to price their gas at 1. This scenario. Such a strategy may work in the very short run. consumers will quickly determine that they can purchase gasoline elsewhere at a lower price.

leaving a branded refiner without distribution in an area.who can succeed in the relevant area. 21 . these are tasks that a jobber may find easier to perform than a refiner’s employees. Both jobbers and franchised dealers could gain from this “arbitrage” opportunity. where escalating real estate prices may give a jobber the chance to profit by selling its real estate properties to a non-gasoline related firm. it could eliminate much of the compensation they receive for developing and promoting franchised dealer operations. This creates the potential for the jobber to resell the gasoline to the refiner’s franchised dealers profitably. if refiners allowed this activity to occur. To stop this type of economic arbitrage. For example. However. refiners use non-price vertical restraints. jobbers often have contractual agreements with more than one branded refiner. This problem may be especially acute in or near a congested urban area. Especially in rural areas. A jobber can also abandon a territory. Such jobbers could switch the brand of a portion of their chain with relative ease. including arranging the delivery of product to its own stations. Because of the additional services the jobber performs. thus leading to the potential for “free riding” on the refiner’s brand name. at least in the short run. as discussed below. it typically receives gasoline at a lower (wholesale) price than franchised dealers. The major disadvantage of the jobber form of retailing is that it is difficult for the refiner to monitor the jobber’s marketing tactics.

At around that same time. 2002 at 21. In the short run. ExxonMobile Fuels Marketing Director. Hypermarkets often serve to enhance refiner interests. that integrated refiners still engage in important competition in gasoline product quality. Regional Director. however. Statement of James Carter. it is a goal of refiners to increase the demand and price for their wholesale product. 22 . and then induce those customers to come inside their stores and buy other products.” Permanent Subcommittee of Investigations of the Committee on Governmental Affairs. April 30. U. the retailing strategy for hypermarkets is to attract customers to their stores through a low price of gasoline and a large number of gasoline pumps. and Wal-Mart (the last three all hypermarkets) in various locations across the country.IV. federal regulations required refiners to change the environmental specifications of their “base” gasoline to a relatively uniform standard. 7 8 For ease of exposition. The Rise of Hypermarkets Hypermarkets and “super convenience stores”7 are non-traditional retail outlets that specialize in selling high volumes of gasoline at prices near the wholesale price of gasoline. in turn. (It should be noted. increased the ability of unbranded retail outlets to sell gasoline to consumers. increasing the demand for gasoline and. therefore. hypermarkets can serve as remunerative outlets for gasoline a refiner cannot use in its distribution channels. these stories together will be referred to as “hypermarkets” from now on. if refiners believe this is more profitable than maintaining or adding to its distribution chain. These extremely competitive marketers drive down (gross) retail margins. In general. One industry source forecasts that hypermarkets will grow from their 2002 level of 13 percent of the industry to 16 percent in 2005. This. This is not surprising. Senate.)8 Hypermarkets obtain at least some of their gasoline product from integrated refiners who also have their own distribution networks. Costco and Albertson’s in the West. In the longer term. refiners may choose to sell gasoline to hypermarkets on a continuous basis. Hearings on “Gas Prices: How Are They Really Set?. This made the “base” gasoline sold by unbranded firms more competitive. as hypermarketers advanced the one-step shopping concept. In addition. The rise of hypermarkets appears to have begun in the mid-1990s. in the long run. and such firms were better able to provide product comparable to that sold in branded outlets. increasing refiners’ profit potential. Firms in this category across the country include Wa-Wa and Sheetz (super-convenience stores) in the Northeast.S.

be a function of whether or not Figure 5 Theoretical Competitive Zone Development 9 See http://www. These include the competitive conditions in a station’s trading area. Nonetheless. Each refiner determines the nature of its price zones. Differences in wholesale prices among price zones in a particular region can reach up to several cents per gallon.V. at 5) and typically. and flows of traffic between working centers and residential areas. despite the limited differential between competing stations.htm. jobbers and their organizations to require refiners to offer the same prices on product to all customers in a geographic area. and the price to be charged in that zone. various legislative proposals have been put forward by franchised dealers. though most price differences appear much smaller (Maryland Task Force. 23 . The size and configuration of a price in a zone may. For example. Issues Surrounding Zone Pricing The FTC has described zone pricing as “the practice whereby refiners set uniform wholesale prices and supply branded gasoline directly to their company-operated and franchised dealer stations within a small but distinct geographic area called a 'price zone'.ftc. 2001. congested bridges and highways. A graphic depicting a typical zone-pricing situation is shown as Figure 5. The price level in an area is based primarily on competitive issues. based on a variety of competitive factors. This figure shows how the path of an interstate highway determines the boundary of the price zone. Firms look at competitors’ prices in the area when setting up their own zones.” 9 Zone pricing is a reflection of the refiner’s recognition that there are different competitive conditions in different geographic areas. in large part.gov/opa/2001/05/westerngas. Such impediments can include a river or a set of hills. stations in areas with gasoline hypermarkets need lower wholesale prices in order to remain competitive. Other factors in zone identification could be differences in local taxes and different government gasoline specifications. as well as the physical nature of the zone based on natural and artificial impediments to consumers’ purchases. the price difference between neighboring stations is minimal.

12 In certain circumstances price discrimination is illegal under the Robinson-Patman Act. Senate.” Permanent Subcommittee of Investigations of the Committee on Governmental Affairs. and that’s our basic philosophy. (See Maryland Task Force. and changes in the station’s retail price. U. 10 See the discussion along these lines in Majority Staff of the Permanent Subcommittee on Investigations.10 One industry executive has explained zone pricing in a more intuitive fashion:11 It’s the dynamics of meeting competition. “Gas Prices: How Are They Really Set?. and reduce them to others. Chevron Texaco Corporation. Price discrimination is offering a product that costs the same at at least two different prices to competing customers. while allowing the franchised dealer to remain competitive. The existence of different price zones has been used by some franchised dealers and their trade associations in their attempt to show the existence of economic price discrimination. In recent years refiners have been using sophisticated decision support systems to help define and set prices in price zones.) The precise nature of price zones differs from company to company. and who do you want to compete against and why and figuring out where to set your price relative to those. Zone pricing is just that. First. 1995). would have two negative consequences for consumers and refiners alike. so that you can get the volume that you need and the balance between volume and price and margin is what generates the cash to run the business. It is figuring out what’s the relevant area of competition. 2001. for example Shaffer and Zhang. North American Products.S. With the introduction of more non-traditional retailers like super convenience stores and hypermarkets. And it sounds mysterious. eliminating price zones could result in some retailers being unable to compete and could result in failure of some sites and thus affect the overall level of competition in this sector. The legal rules of this law are extremely complicated. higher prices for consumers. 11 12 13 24 . Thus. U. Senate. The reason is that eliminating zone pricing would change the focus of competition from many retail outlets to only a few terminal locations. Price zones are not the cause of the competitiveness of such locations. It should be noted that price zones are the consequences of different levels of competition in differ- ent areas. the systems will estimate which wholesale price will maximize the refiner’s profits. President. as sought by some franchised dealers and their associations. 278-286). The resulting “softening” of competition will likely generate. to say the least. see Viscusi. One refiner has a price zone for almost every station. optimizing his profits as well. Hearings on “Gas Prices: How Are They Really Set?. For an economic discussion of the Robinson-Patman Act. requiring equal prices would raise prices to some dealers of a particular supplier. Another has over half of its price zones consisting of only one station. April 30 at 21.S. on net. and it sounds complicated. at 6. These systems will estimate a station’s gasoline volume as a function of the factors discussed above.there is a hypermarketer in the area. and will not be discussed at length here. Vernon and Harrington (1992.13 Eliminating zone pricing. David C. The Robinson-Patman Act is routinely criticized by scholars for many of the reasons presented here. indicates that prices are more likely to rise on average than to fall. Given this. It should be noted that economic definitions of price discrimination can vary. Low price zones are thought of by refiners as “help to the dealer” – they keep the franchised dealer in business while meeting competition in low price areas. zone pricing has become a mechanism designed to help dealers compete and respond to the new marketing challenges. Other companies will generally have several stations in most price zones. however. as well as from region to region.” (2002 at 302). Recent economic research (see. Reeves. but it is actually as simple as meeting local competition.

depending on the destination of that gasoline. on net. the elimination of zone pricing raises prices in more competitive markets by approximately 11 percent.) In addition. Senate. Second. Professor of Economics. 16 25 . University of Texas. Experimental economics is a relatively new field of economics that tests economic hypotheses under laboratory conditions. depending upon the time period studied and interpretation chosen of the proposed statute. had zone pricing been eliminated in California in 1997 and 1998. U. under some proposals.8 and 4. Hearings on “Gas Prices: How Are ey Really Set?. Dartmouth University. and the value of the brand to refiners and consumers would decline. According to Professor Justine Hastings of Dartmouth University:15 If refiners are forced to charge one wholesale price. companies give a lower price to the more price sensitive consumers. refiners and retailers would likely be forced to withdraw from low-priced zones. it might have little choice but to withdraw from the low-priced area.14 Deck and Wilson find that. In such a circumstance. received the Nobel Prize for Economics in 2002 for his contributions in th is area. U. currently the most price sensitive neighborhoods. reducing competition further.” Permanent Subcommittee of Investigations of the Committee on Governmental Affairs. Testimony of R. like students and senior citizens. (See Maryland Task Force. in the laboratory. it will tend to increase prices in the most competitive and also the poorest areas. Zone pricing is essentially the same phenomenon as the senior citizen discount at the movie theater. without the tool of zone pricing. Deck and Wilson “simulate” gasoline markets through the use of experimental economics. increase average prices to consumers by reducing the level of competition between stations. some refiners are experimenting using zone pricing with jobbers. 2002 at 114. Hastings emphasized. Professor R. Senate subcommittee in 2002 made similar arguments. as well as the value of their brands. could not reduce the wholesale price at that location without doing so in the entire terminal tributary area or. In addition. 2001 at 9. reducing competition in those areas. 14 15 e founder of experimental economics. Vernon Smith. is study indicates that. Senate. us.S. a refiner would be reluctant to lose margin in a large area in order to remain competitive in a smaller one. Hearings on “Gas Prices: How Are ey Really Set?. as Dr. a refiner facing competition from a hypermarket. Preston McAfee.” Permanent Subcommittee of Investigations of the Committee on Governmental Affairs. they certainly would rise in low-income neighborhoods. is would have cost California motorists between $419 million and $625 million dollars per year in higher gasoline prices. Under uniform pricing. In the long run. It is also quite common for jobbers to use zone pricing when they supply their own franchised outlets. April 30. Assistant Professor of Economics. Instead.S. an entire state. 2002 at 117.Consistent with this.S. Similar results are found in a recent working paper by Deck and Wilson (2003). charging them a different price for gasoline at the rack. Two other economists speaking before a U. e elimination of zone pricing also serves to redistribute profits away from refiners toward the owners of stations in less competitive markets. it actually could be the case that average wholesale prices would rise. Comanor and Riddle (2003) found that requiring uniform pricing in California would. April 30. brand maintenance would suffer.6 cents per gallon higher on average. retail gasoline prices would have been between 1. Zone price elimination could be a very regressive policy. Preston McAfee of the University of Texas made a similar statement:16 Elimination of zone pricing by statute will not tend to reduce average gasoline prices. Testimony of Justine Hastings. e elimination of zone pricing has no effect on prices in less competitive markets. at is.

if the two firms being sued for collu- 17 18 See http://www. For example. They allow both the refiner and the franchised dealer to engage in brand investment without the threat of “free-riding” on those brand investments by a jobber. Thus. B. rather than the protection of individual competitors. The Motivation for Non-Price Vertical Restraints As discussed above.” These restraints are useful to refiners because the price differential that causes them is required for refiners to recoup their investments in dealer operated stations.gov/os/2001/05/wgspiswindle. The territory these jobbers can operate in. it should be noted that the term “redlining” is a pejorative that does not accurately represent the practices in question. and 2) site-specific. they may restrict investments in their brands. A theory of anticompetitive behavior has several elements.ftc. the firms using the practice at issue must be competing in a relevant product and geographic market. refiners engage in a series of non-price vertical restraints with their jobbers that preclude them from selling gasoline outside their assigned territories. Fourth. Each of these factors may be important in the determination of the outcome of an antitrust case. These investments include developing distribution systems. together. under the antitrust laws. which they refer to as “redlining. however.S. Neither outcome would serve the consumer interest. v. often highly restricted. Second. they may reduce the number of jobbers they use. the firms using the practice at issue must. and that the balance of the evidence supports that theory. non-price vertical restraints have been evaluated under the standard of “rule of reason. have market power in the relevant market. Should these territorial restrictions be prohibited. Issues Surrounding Non-Price Vertical Restraints A. in which the contract includes financial disincentives for the jobber to sell in locations directly supplied by the refiner and prevents a jobber from shipping low-priced gasoline to stations located in high-priced zones. It cannot be stressed enough that the focus of antitrust enforcement is the protection of consumers. Second. in which the contract between the refiner and the jobber gives the refiner the right to refuse to approve the jobber's request to supply branded gasoline to independent stations or supply its own stations in specific price zones. These jobbers have asked their elected officials to enact legislation to end such restrictions. Thus.V. financial support. as the number of branded sites would be reduced. non-price vertical restraints are clearly useful tools for brand support. using that branded name and selling the refiner’s gasoline. refiners often allow independent operators known as “jobbers” to sell their branded gasoline in certain areas. siting costs. any anticompetitive resulting behavior must outweigh the impact of any efficiencies from these practices.” This rule implies that for a plaintiff to succeed in such a case.17 “[t]here are two general types of redlining: 1) territorial. is. generally through enhancing tacit collusion. replacing them with less efficient forms of distribution. or choose not to use jobbers when expanding their distribution channels. Third.htm. Inc. Antitrust and Non-Price Vertical Restraints Since the 1977 Sylvania 18 decision. refiners can be expected to act in at least one of two different ways.) According to the FTC. it must show a logical theory of consumer injury. and responsibility for environmental concerns. First. 26 . GTE Sylvania Inc (1977) 433 U.” (Of course. 36. First. Continental T. the use of the practice must in some logical manner encourage supracompetitive pricing.VI.

The same analysis holds true for a gasoline refiner deciding how it should distribute its own product. For a broader discussion of these issues. under the antitrust laws. But there is no reason to conclude that consumers would be injured.” The reason for this is clear: non-price vertical restraints in this industry are unlikely to harm consumer welfare. that is likely to be a fatal flaw in a case. Refiners invest in a variety of promotional and other activities for franchised dealers. however asserts that non-price vertical restraints should be eliminated to enhance what is referred to as “intrabrand competition. the choice of whether or not to allow “intrabrand” competition should be left solely to the refiner. GTE Sylvania Inc. In many areas AT&T sells cellular telephones through both its own corporate stores and through independent franchises.sive behavior in a matter compete in separate cities. there is no purely “competitive” implications that arise from an AT&T decision to allow. see Klein and Murphy (1988). If it finds that using franchisees lowers its total cost. Thus. In this case the dominant firm is unlikely to be colluding with any of its rivals. 2003) “With respect to the antitrust laws. it has that power whether or not it uses independent franchises as well as company owned stores. the landmark decision of the United State Supreme Court in Continental T. so the relevant restraint is unlikely to be harming consumers.. proconsumer. [433 U. For example. The fourth point is important to remember. Thus. it is clear that under the antitrust laws the chances of successful litigation are extremely limited. the necessity of an anticompetitive theory. and no other firms use the practice. For example.” AT&T seeks to deliver its product at the lowest cost. according to the position paper prepared for the jobber trade group the Petroleum Marketers Association of America (Bassman. The third condition. 19 20 The PMAA. “intrabrand competition” in its own product.S. it will use them. v. The competition between the two is referred to as “intrabrand competition. can also be problematic. one must ask why AT&T would choose to allow intrabrand competition? The answer comes from AT&T incentives as an “upstream producer. AT&T can control (through setting retail and/or wholesale prices) the quantity of cellular telephones sold. see Liebelier (1982). non-price vertical restraints serve to protect the refiner’s investment in the franchised dealer’s location. efficiency rationales. For a fuller discussion of these issues.” Such “competition” would be reduced were AT&T to eliminate its independent franchises. 27 . Inc.V. 36 (1977)] all but dooms jobber hopes of finding a basis in the antitrust laws to attack redlining. They recoup these investments through higher wholesale margins.20 If AT&T has market power in the relevant area.” Intrabrand competition occurs when a firm uses two or more distribution networks in the same area. then that also is a fatal flaw in a case. In either circumstance. but not head to head. outside of the gasoline business. Indeed. Therefore. then it will be “free riding” on the refiner’s investment. This is similar to the incentives of an integrated refiner to lower its costs for distributing its gasoline. If the firms at issue constitute only a small portion of a market. Given this.. If the direct service operator can obtain its gasoline from another source able to lawfully supply the same brand of gasoline. all other things being equal. or to end. assume that the firm using the practice at issue is dominant in the market. it is useful to examine AT&T’s sales of cellular phones. say 10 percent. The refiner has the same incentives as the consumer of gasoline – to minimize the distribution costs of the product. Mitchell and Alfano. Nonprice vertical restraints can have important. However.19 Franchisees who take exception to a refiner’s actions have recourse in the courts. says a local jobber.

Whose Interests Are Being Served? Charges against refiners’ administration of their retail gasoline distribution network often come from jobbers and other competitors of refiner affiliated stations. They restrict jobber profits by restricting the places they can sell gasoline. shifts profits away from refiners and toward station owners. The reason for this is simple: Lower distribution costs increase the profit potential of refiners. This needs to be understood in order to evaluate the claims made against the retail gasoline system. Refiners prefer low cost distribution methods to high cost methods. and public policy in general. at the same time. As Baumol and Ordover (1984) point out. eliminating zone pricing. as the results of Deck and Wilson (2003) indicate. that decision can be expected to be generated by the refiners’ belief that jobbers do not represent the lowest cost method of distribution in those areas. not protecting the profits of any level of production or any individual firm. are not always friends of the antitrust laws or the general public interests. Market participants.” Protecting competition means moving to provide customers with the lowest sustainable prices. is to protect the interests of the consuming public. Jobbers have worked with their political representatives in attempts to end vertical restraints. Thus. if. they prefer higher profits to lower profits for their segment of the network. “there is a difference between protecting competition and protecting competitors. everything else being equal. these actors often have economic interests that are contrary to both the refiners and the final consumer. as the old saying goes. They can gain higher profits through their marketplace actions. They may also be able to gain profits through political activity. therefore. One should remember that refiners.VII. It is not to increase the profits of any level or type of distribution. however. although they clearly prefer higher profit to low. The reason for this is simple: these vertical restraints limit jobber profit opportunities. Dealers have reasons to desire the end of zone pricing. If refiners choose not to use jobbers in particular areas. lower prices to consumers. while raising prices to consumers. 28 . and. Being economic agents. as well as from franchised dealers and their trade associations. The purpose of the antitrust laws. have the proper incentives to choose their own distribution methods.

Margins have been decreasing in the gasoline marketing segment. that margins fluctuate when measured on a yearly basis. Petroleum Marketing Annuals. Figure 6 Gross Gasoline Marketing Margins. it may be more accurate to examine marketing margins by using three year moving averages.S. and bulk for all grades of gasoline as reported by the Energy Information Administration. from $0. rack. 1983-2002 21 2003 cents per gallon Gross gasoline marketing margins are calculated as the difference between the average retail price of all types of gasolines (excluding federal and state taxes) and the weighted average sales for resale price from the dealer tank wagon. have declined about 8 cents per gallon. the best way of analyzing the gasoline marketing sector is by the extent of margins in the sector. The lower the margins.197 per gallon in 2002. the bottom line is clear. however.VIII. Thus. the lower prices are to consumers. in constant 2003 dollars. Gross marketing margins for gasoline in the U. Gross Gasoline Marketing Margins In the end. Given this. Table 31. a decline of 19 percent. 29 . from 1983. Figure 6 graphs out the gross marketing margins for gasoline in the U. from $0.203 in 2002.252 in 1985 to $0. These figures are indications that competition in this area has acted to serve competitors and consumers alike. in constant 2003 dollars. It appears.277 per gallon in 1983 to $0. This is an indication that competition in this area has acted to serve integrated refiners and consumers alike. Employing this metric. we observe that margins fell an average of 5 cents per gallon. a drop of 29 percent. from 1983.21 It is clear that since 1983 there has been an important decline in retail gasoline margins.S.

In response to their needs in the marketplace. however. different firms will adopt one or more of several different types of distribution systems. Similarly. shows that these critiques are not valid. refiners use nonprice vertical restraints with their downstream affiliates. Refiners also use zone pricing to meet competitive threats in different markets. and generate incentives for the proper level of investment. The analysis of this paper. research has shown that the elimination of zone pricing would result in higher average prices for consumers. No coherent anticompetitive theory of the relevant non-price vertical restraints exists. To eliminate these practices would be harmful to the consuming public. Indeed.IX. To alleviate these tensions. The retail gasoline marketplace is subject to a wide variety of competitive forces. these calls are misguided. however. between these distribution systems. when they coexist in the same marketplace. with their different levels of control and investment by refiners. Tensions can arise. claiming that they reduce competition in various markets. It would also force many refiners to exit from more competitive retail markets. Conclusions Critics of the retail gasoline sector have called for the abolishment of non-price vertical restraints and zone pricing in this industry. opponents of such restraints admit that these restraints are unlikely to violate the antitrust laws. The strategies at issue are the result of competition between various forms of distribution in gasoline marketing. Several parties have criticized the use of non-price vertical restraints and zone pricing. From a competitive viewpoint. 30 . Eliminating the ability of refiners to use such restraints would likely reduce their investments in distribution outlets and harm consumers. however.

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P. Professor of Energy and Environmental Economics The Pennsylvania State University ANK1@psu.edu 814-865-0711 December 2003 . Kleit.D.Andrew N.h.