Working Paper: NBER ID: w4618
Authors: Patrick Rey; Joseph Stiglitz
Abstract: The central objective of this paper is to show how vertical restraints, which affect intra-brand competition, can and will be used as an effective mechanism for reducing inter-brand competition and increasing producer profits. We show how exclusive territories alter the perceived demand curve, making each producer believe he faces a less elastic demand curve, thereby inducing an increase of the equilibrium price. The use of exclusive territories may increase producers' profits, even if the producers cannot charge franchise fees, and so cannot recapture, from the retailers, the monopoly rents they earn from their exclusive territory: we show that 'double marginalization' effects can be overcome by the strategic effect on producers' competition. We provide a model in which we can clearly specify the full range of feasible contracts between producers and retailers, and show that it is always a dominant strategy for firms to use exclusive territories (so that exclusive territories are used in equilibrium) and that the best situation from the producers' viewpoint may or may not entail franchise fees. In all cases, exclusive territories hurt consumer surplus and reduce total welfare, which yields a different light on vertical restraints from a competition policy perspective.
Keywords: vertical restraints; exclusive territories; producer profits; interbrand competition; consumer welfare
JEL Codes: L13; L41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| exclusive territories (L14) | perceived reduction in demand elasticity (D12) |
| perceived reduction in demand elasticity (D12) | higher equilibrium prices (D41) |
| exclusive territories (L14) | higher equilibrium prices (D41) |
| exclusive territories (L14) | increase producer profits (D21) |
| exclusive territories (L14) | facilitate collusion among producers (L12) |
| facilitate collusion among producers (L12) | increase joint profits (L21) |
| exclusive territories (L14) | higher prices in absence of competitive pressures (D49) |