Collusion, Price Discrimination, and Retailer Bond

This paper analyzes cartel formation in a supply chain in which upstream firms sell to two retailers that are heterogeneous in their marginal retail costs. Colluding upstream firms price discriminate in favor of the more efficient downstream firm. This increases the difference between profits from upstream collusion and competition for the efficient retailer and creates a bond with the colluding upstream firms. This bond weakens the retailer’s incentive to accept deviation offers and allows the cartel to implement prices above cost for any strictly positive value of the discount factor. A vertical merger with the more efficient retailer makes consumers worse off as the cartel can sustain higher prices. A merger with the less efficient retailer disrupts the cartel and is procompetitive when retailer asymmetry is sufficiently strong.