Tie-In Contracts with Downstream Competition

Abstract

A tie-in contract has recently come under scrutiny for its role as an exclusionary device. A firm that is a monopolist in a primary market can utilize such contracts to exclude a more efficient rival in a secondary market. When the firms sell through competing retailers, the leveraging firm may offer tie-in contracts to the retailers inducing them to purchase both primary and secondary products entirely from it such that the rival is excluded. Assuming both upstream firms to be strategic, we find that whether such tie-in contracts are profitable or not depends on the type of competition at the downstream level. When retailers compete in prices, a tie-in strategy becomes strictly more profitable regardless of commitment status and the difference in costs of the upstream firms. This results holds even when retailers are differentiated and price competition is less intense. When retailers compete in quantities, commitment and cost status become relevant. Under commitment, a tie-in strategy can be strictly inferior if the rival firm's cost is significantly lower. Absent commitment, a tie-in contract is not feasible.