A Contracting Model of Differentiation through Input Exclusivity

Abstract

In many industries – including wireless telecommunications, automobile retailing, and pay-TV – input providers and downstream firms often enter into exclusive contracts to differentiate themselves from their competitors. This paper studies the adoption and effects of such contracts in a model of bilateral contracting between two manufacturers and two retailers in which the choice of final prices or quantities is delegated to retailers. The existence of an equilibrium characterized by pairwise exclusivity depends on the degree of supplier and retailer differentiation and, less obviously, on the bargaining power of manufacturers and retailers and on whether contract offers are private or public. When a pairwise equilibrium exists, it gives rise to industry profits, consumer surplus and overall welfare that can be higher or lower than in a common agency equilibrium in which each retailer carries both products. In particular, relative to common agency, pairwise exclusivity increases downstream differentiation but prevents joint pricing of products by retailers.