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Vertical Contracts That Reference Rivals

Author

Listed:
  • Fan Liu

    (Nankai University)

  • David S. Sibley

    (The University of Texas at Austin)

  • Wei Zhao

    (Competition Economics LLC)

Abstract

We study two types of vertical contracts that reference rivals: the “vertical price constraint” (VPC) requires retail prices for a manufacturer’s product to be no higher than for its competitors’ products. The “vertical margin constraint” (VMC) requires retail margins for a manufacturer’s product to be no higher than for its competitors’ products. These agreements are found in the soft drink and cigarette industries, and in travel platforms. With two asymmetric manufacturers, we find that only the larger adopts a VPC in a subgame perfect equilibrium. We also analyze incentive compatibility issues with optional VPC agreements. Apart from leading to increased prices, the VPC leads to lower profits for the smaller manufacturer. In contrast, the VMC leads to lower prices. Under certain conditions, by adopting the VMC, a larger manufacturer will gain enough to compensate the retailer and still be better off, while making its competitor worse off. These two vertical contracts work because they alter the price elasticities of demand that face upstream manufacturers.

Suggested Citation

  • Fan Liu & David S. Sibley & Wei Zhao, 2020. "Vertical Contracts That Reference Rivals," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 56(2), pages 381-407, March.
    • Handle: RePEc:kap:revind:v:56:y:2020:i:2:d:10.1007_s11151-019-09702-9
    DOI: 10.1007/s11151-019-09702-9
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    References listed on IDEAS

    as
    1. Chen, Yongmin, 2001. "On Vertical Mergers and Their Competitive Effects," RAND Journal of Economics, The RAND Corporation, vol. 32(4), pages 667-685, Winter.
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    More about this item

    Keywords

    Vertical contract; Vertical restraint; Margin constraint; Every day low price;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D49 - Microeconomics - - Market Structure, Pricing, and Design - - - Other
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
    • L42 - Industrial Organization - - Antitrust Issues and Policies - - - Vertical Restraints; Resale Price Maintenance; Quantity Discounts

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