Vertical Coordination Through Renegotiation

40 Pages Posted: 28 Jul 2011

See all articles by Özlem Bedre-Defolie

Özlem Bedre-Defolie

ESMT European School of Management and Technology; University of Bergen, Economics Department; CEPR IO

Date Written: July 25, 2011

Abstract

This paper analyzes the strategic use of bilateral supply contracts in sequential negotiations between one manufacturer and two differentiated retailers. Allowing for general contracts and retail bargaining power, I show that the first contracting parties have incentives to manipulate their contract to shift rent from the second contracting retailer and these incentives distort the industry profit away from the fully integrated monopoly outcome. To avoid such distortion, the first contracting parties may prefer to sign a contract which has no commitment power and can be renegotiated from scratch should the manufacturer fail in its subsequent negotiation with the second retailer. Renegotiation from scratch induces the first contracting parties to implement the monopoly prices and might enable them to capture the maximized industry profit. A slotting fee, an up-front fee paid by the manufacturer to the first retailer, and a menu of tariff-quantity pairs are sufficient contracts to implement the monopoly outcome. These results do not depend on the type of retail competition, the level of differentiation between the retailers, the order of sequential negotiations, the level of asymmetry between the retailers in terms of their bargaining power vis-à-vis the manufacturer or their profitability in exclusive dealing.

Keywords: vertical contracts, rent shifting, renegotiation, buyer power

Suggested Citation

Bedre-Defolie, Özlem, Vertical Coordination Through Renegotiation (July 25, 2011). ESMT Working Paper No. 11-08. Available at SSRN: https://ssrn.com/abstract=1894584 or http://dx.doi.org/10.2139/ssrn.1894584

Özlem Bedre-Defolie (Contact Author)

ESMT European School of Management and Technology ( email )

Schlossplatz 1
10117 Berlin
Germany
+49(0)30212311531 (Phone)

HOME PAGE: http://www.esmt.org

University of Bergen, Economics Department ( email )

Fosswinckelsgt. 6
N-5007 Bergen, 5007
Norway

CEPR IO ( email )

London
United Kingdom

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