Vertical Contract That Reference Rivals

47 Pages Posted: 9 Nov 2016 Last revised: 6 Aug 2017

See all articles by Fan Liu

Fan Liu

University of Texas at Austin - Department of Economics

David S. Sibley

University of Texas at Austin - Department of Economics

Wei Zhao

Competition Economics, LLC

Date Written: July 14, 2017

Abstract

We study two vertical constraints on pricing which have received little study. A vertical MFN (“VMFN”) refers to an MFN on retail prices that is sought by an upstream manufacturer. A vertical margin constraint (“VMC”) refers to a requirement that the margin earned by a retailer on a manufacturer’s product not exceed what the retailer earns on a rival manufacturer’s product. Vertical agreements containing these constraints are found in the soft drink and cigarette industries.

We study these vertical constraints in the context of two asymmetric manufacturers. In this setting, only the larger manufacturer uses the VMFN. We characterize pure and mixed strategy equilibria and find, as have others, that the VMFN raises prices, relative to a benchmark case. The VMFN harms the retailer and the small manufacturer, helping the larger manufacturer. This can lead to foreclosure of the small manufacturer. The VMC has opposite effects, leading to lower prices and higher retailer profits than in the benchmark case. It requires pre-commitment by the retailer in order to be used.

Keywords: Vertical Contract, Vertical Restraint, Margin Constraint, Everyday Low Price

JEL Classification: D21, D49, L14, L42

Suggested Citation

Liu, Fan and Sibley, David S. and Zhao, Wei, Vertical Contract That Reference Rivals (July 14, 2017). Available at SSRN: https://ssrn.com/abstract=2866029 or http://dx.doi.org/10.2139/ssrn.2866029

Fan Liu

University of Texas at Austin - Department of Economics ( email )

2225 Speedway Stop C3100
Austin, TX 78712
United States

David S. Sibley

University of Texas at Austin - Department of Economics ( email )

Austin, TX 78712
United States

Wei Zhao (Contact Author)

Competition Economics, LLC ( email )

2000 Powell Street
Suite 1425
Emeryville, CA 94608
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
165
Abstract Views
824
rank
213,503
PlumX Metrics