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Vertical Integration and Exclusivity Contracts when Consumers Have Switching Costs

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  • Tommaso M. Valletti

Abstract

This article extends the literature on switching costs by considering what happens when retailers and manufacturers are separate entities and some customers are locked in with retailers. This separation introduces a dynamic inconsistency problem as manufacturers face the problem of extracting too much surplus from the retailer in which case the retailer has no incentive to build a subscriber base. It is shown that different trading relationships arise according to the nature and magnitude of switching costs. When switching costs are high, then integrated structures are always predicted (or exclusive dealerships in case vertical integration is banned). Vertical integration should be allowed as it provides high‐powered incentives to acquire market shares.

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  • Tommaso M. Valletti, 2004. "Vertical Integration and Exclusivity Contracts when Consumers Have Switching Costs," Southern Economic Journal, John Wiley & Sons, vol. 71(1), pages 36-59, July.
    • Handle: RePEc:wly:soecon:v:71:y:2004:i:1:p:36-59
    DOI: 10.1002/j.2325-8012.2004.tb00622.x
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    References listed on IDEAS

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    1. A. Jorge Padilla, 1992. "Mixed Pricing in Oligopoly with Consumer Switching Costs," Working Papers wp1992_9203, CEMFI.
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    4. Inderst, Roman & Wey, Christian, 2003. "Bargaining, Mergers, and Technology Choice in Bilaterally Oligopolistic Industries," RAND Journal of Economics, The RAND Corporation, vol. 34(1), pages 1-19, Spring.
    5. Tommaso Valletti, 2000. "Switching Costs in Vertically Related Markets," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 17(4), pages 395-409, December.
    6. Muthoo,Abhinay, 1999. "Bargaining Theory with Applications," Cambridge Books, Cambridge University Press, number 9780521576475, January.
    7. Katz, Michael L., 1989. "Vertical contractual relations," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 1, chapter 11, pages 655-721, Elsevier.
    8. Paul Klemperer, 1987. "The Competitiveness of Markets with Switching Costs," RAND Journal of Economics, The RAND Corporation, vol. 18(1), pages 138-150, Spring.
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