Competition with Aftermarket Power when Consumers are Heterogeneous

Abstract

We study a model of competitive foremarkets and partly monopolized aftermarkets. We show that high aftermarket power prompts firms to engage in inefficiently aggressive below-cost pricing in the foremarket. This inefficiency is driven by the presence of consumers with valuations below marginal cost. While for intermediate aftermarket power their presence leads to a competition-softening effect, for high aftermarket power firms attract increasing numbers of unprofitable consumers by aggressively pricing below cost. For high aftermarket power, firms' equilibrium profits can therefore be decreasing in aftermarket power but are always higher than for low aftermarket power. If firms engage in price discrimination by bundling the foremarket and aftermarket goods or by reducing their aftermarket power, they avoid selling to unprofitable consumers but also reduce the competition-softening effect. This decreases firms' equilibrium profits but increases consumer and social welfare.

Note: An earlier version of this article circulated under the title "Why Aftermarket Can Be Bad for Firms."

Keywords: Aftermarkets, Bundling, Consumer Heterogeneity

JEL Classification: L11, L41