Vertical Contract That Reference Rivals
47 Pages Posted: 9 Nov 2016 Last revised: 6 Aug 2017
Date Written: July 14, 2017
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: Suggested Citation