Vertical control of a distribution network—an empirical analysis of magazines

Abstract

How does an upstream firm determine the size of its distribution network, and what is the role of vertical restraints? To address these questions, we develop two empirical entry models. In the benchmark coordinated entry model, the upstream firm sets market‐specific wholesale prices and implements the first best. In the more realistic restricted/free entry model, the upstream firm only sets a uniform wholesale price. As a second‐best solution, it restricts entry in markets where business stealing (encroachment) is high, and allows free entry elsewhere. We apply the model to magazine distribution, and assess the profitability of alternative vertical restraints. Banning restricted licensing reduces profits only slightly, so the business rationale for restricted licensing should not be sought in the prevention of encroachment. Furthermore, market‐specific wholesale prices implement the first best, but the profit increase would be small, providing a rationale for the commonly observed uniform wholesale prices. Finally, uniform franchise fees are much less effective than a uniform wholesale price to cope with local market differences.