Strategic Vertical Market Structure with Opaque Products

Abstract:     
This paper studies the strategic introduction of an opaque channel by incumbent firms. We endow a circular city model with an intermediary that sells lotteries (opaque products) over goods produced by upstream firms. Compared to the benchmark model (Salop, 1979), opaque intermediation creates value (welfare) by increasing the intensity of price competition and expanding industry sales, but the effect on the value captured by the firms is ambiguous. We show that firms can use the opaque intermediary as a facilitating device to price discriminate and increase profits when the degree of product differentiation takes intermediate values. As an example, we consider the use of opaque intermediaries in markets exposed to seasonal demand. The value captured by the firms increases if the lower profits due to intense competition when demand is high are outweighed by the benefits of expanding the extensive margin when demand is low.

Number of Pages in PDF File: 28

Keywords: Vertical market structure, Opaque products, Circular city, Intermediation, Price discrimination

JEL Classification: D43, L11, M31

working papers series