Supplier Encroachment and Consumer Welfare: Upstream Firm's Opportunism and Multichannel Distribution

Abstract

I revisit supplier encroachment under the framework of a two-part tariff contract. When a monopoly manufacturer supplies competing retailers and each retailer's contracting process is unobservable to the rival, the retailer's lack of knowledge vis-à-vis its rival's contract may undermine the manufacturer's commitment power, which prevents the manufacturer from achieving optimal profit. I demonstrate that when the manufacturer directly supplies the retail market, it can use the direct channel as a commitment tool and thus restore its market power. Even though the manufacturer's encroachment creates more competitors in the retail market, the resultant higher wholesale prices cause significant loss in the indirect channel, which may reduce consumer welfare in equilibrium. Moreover, the efficiency enhancement of the manufacturer's direct channel can be detrimental to consumer welfare. These results hold even when the manufacturer is very efficient in direct selling.

Keywords: channels of distribution; encroachment; two-part tariff contract; supplier opportunism; consumer welfare

JEL Classification: L14, L22, M11