RPM and Vertical Integration with Upstream Competition and Noncontractible Efforts
40 Pages Posted: 13 Aug 2024
Date Written: August 01, 2024
Abstract
Models of vertical contracting often find that non-linear pricing schedules such as two-part tariffs constitute a perfect substitute for resale price maintenance (RPM) or vertical integration. Yet, RPM and vertical integration are ubiquitous in practice. In this paper, we explain the incremental value of strategies like RPM and vertical integration, and thus rationalize firms' vertical restraints and integration strategies, without either resorting to ad-hoc restrictions on the contract space or considering downstream competition. We do so by building a common agency model where two differentiated manufacturers compete for representation at a single retailer and, critically, where there is double moral hazard, meaning that noncontractible efforts at both levels of the supply chain can boost demand for the final products. In this setting, we find that RPM and vertical integration have incremental effects even when firms can use two-part tariffs. We show that, absent vertical integration, RPM is a strict best response for each manufacturer, and that it increases consumer welfare. But by intensifying competition, RPM may reduce manufacturers' profits. With regard to vertical integration between one of the manufacturers and the retailer, we show that it is always profitable, and it increases consumer surplus as long as non-contractible effort is reasonably important or product differentiation is either high or low. Furthermore, vertical integration can increase the profit of the unintegrated manufacturer.
Keywords: Vertical Integration, Resale Price Maintenance, Noncontractible Effort, Double Moral Hazard, Common Agency
JEL Classification: L42, L50, L81
Suggested Citation: Suggested Citation