Downstream Competition Research Articles

Vertical mergers without foreclosure

AbstractThe typical concern about vertical mergers is the foreclosure of downstream rivals. In a vertically related industry where downstream firms have a common supplier, margins can reveal whether upstream competition constrains that supplier. I develop a test (based on margins) to identify whether the supplier is constrained premerger and, consequently, cannot raise input prices postmerger. However, even without foreclosure in equilibrium, vertical mergers can harm consumers. Vertical mergers increase consumer prices and benefit all firms, including downstream rivals, when downstream (horizontal) competition weakens sufficiently. This theory of harm differs from typical theories, which pit the merged entity against downstream rivals.

Analysis of the Impact of Innovation Subsidy Policy on Biological Enterprises

BASF, one of the world's leading chemical enterprises, has been actively engaged in biotechnology in recent years, committed to integrating biotechnology with traditional chemical technology and promoting the development of sustainable solutions. This report aims to analyze BASF's financial statements for 2021, 2022, and others to evaluate the performance of its biotechnology business in four key aspects: solvency, upstream and downstream competition, profitability, and operating capacity, to provide a reference for corporate decision-makers and investors. According to the public information, BASF is financially stable, and its ROCE has increased significantly, reaching 13.5% in 2021, far higher than the cost of capital, which shows the company's strong profitability and good solvency. BASF's biotechnology business has performed well in profitability. The bio-solution business contributes more than 150 million euros in annual sales and continues to grow. BASF's biological control products, seeds and traits business have been registered or are being registered in many countries, showing strong market potential and profitability. BASF also performed well in the operational capability of biotechnology business. The company has established lean corporate headquarters and global business service department to provide efficient and demand-oriented internal services. With the intensification of market competition and the continuous progress of technology, BASF needs to continue to increase R&D investment, expand market share, optimize supply chain management and improve operational efficiency in order to maintain its leading position and achieve sustainable development.

Competing buyers’ investment and ordering strategies under supply disruption

Supply chain disruptions can be costly and disruptive, and reducing supplier uncertainty through investments can be an effective strategy for mitigating these risks. In this study, we explore ordering and investment strategies in a downstream competitive environment, considering supply uncertainty. We consider two buyers ordering from a single supplier and competing in a Cournot market. Buyers must balance investment benefits against costs when making investment decisions. We find that without downstream competition, a relatively low investment proportion can yield a “win-win” outcome. Under downstream competition, an increased number of investors does not necessarily lead to higher supplier reliability. When both buyers invest at a high ratio, the significant decline in order quantities may results in lower supplier reliability. When there is only one investing buyer in the market, even though the competitor may benefit from spillover reliability enhancement — free-riding, the buyer may also be willing to provide an investment subsidy to improve the supplier’s reliability. When both buyers invest at a moderate ratio, downstream competition may benefit all supply chain members. Moreover, increasing wholesale price differentiation and endogenous investment ratios can effectively reduce free-riding behavior of the non-investing buyer. These findings have practical implications for supply chain managers aiming to reduce supply risks and allocate investment resources efficiently.

First-party selling and self-preferencing

In this paper, I analyze the welfare effect of a vertically integrated gatekeeper platform selling its own first-party product, i.e., first-party selling, as well as the platform's incentive to favor the first-party product in the product recommendations it makes, i.e., self-preferencing. I find that, irrespective of self-preferencing, both consumer welfare and platform revenue are higher under first-party selling because first-party selling mitigates double marginalization. Additionally, third-party product prices are lower in expected terms under first-party selling, either because the platform reduces the commission fee (with self-preferencing) or downstream competition is fiercer (without self-preferencing). Finally, I show that both consumers and the platform are better off if the platform commits not to engage in self-preferencing.

Naked exclusion with heterogeneous buyers

We investigate the effects of buyer heterogeneity in a market where an incumbent firm deters entry when it signs enough exclusionary contracts with buyers. With heterogeneous buyers, several well-known results in exclusionary contracting with homogenous buyers are overturned and novel ones emerge. First, inefficient equilibria exist in which exclusionary contracts are signed but entry still occurs, and the loss of consumer surplus falls on small buyers. Second, sequential contracting may be more pro-competitive than simultaneous contracting in the sense that entry occurs under sequential but not simultaneous contracting. When this happens, sequential contracting Pareto dominates simultaneous contracting. We extend our analysis to consider downstream competition and breach of contract.

Tax motivated vertical FDI and transfer pricing

We examine a domestic downstream producer that acquires a foreign input supplier with the aim of manipulating the transfer price and shifting profits from a high-tax to a low-tax country. The multinational enterprise faces a trade-off: insourcing the input at a high transfer price reduces the corporate tax burden but at the cost of increasing the input cost of its downstream division, which reduces domestic sales and profits. The optimal transfer price balances this trade-off. Regulation under the arm’s length principle is shown to reduce the transfer price, which reduces distortion in the domestic production and expands the region in which vertical FDI benefits consumers and social welfare in the home country. We also show that promoting downstream competition could help align private and social incentives, reinforcing the positive effects of regulation.

Downstream Competition and Upstream Innovation: Theory and Evidence from China

Abstract Competition is the catalyst of corporate innovation, which is the foundation of a country’s core competitiveness. From the view of vertical industrial chain, this paper examines how downstream competition affects upstream firms’ innovation output. Given innovation helps reduce the production cost of each product, increasing demand of intermediate products caused by downstream competition enhances the marginal revenue of upstream firms’ innovation, thus leading to an innovation incentive effect. To identify causality, we utilize China’s WTO accession, a quasi-natural experiment, to calculate downstream competition combined with import tariff reduction and input-output table, and then run a difference-in-difference regression. Using the data of Annual Survey of Industrial Firms and State Intellectual Property Office, our results find that downstream competition has a significantly positive impact on upstream firms’ innovation, and this effect is more pronounced in firms with less industry competition, greater initial innovation capacity and weaker financial constraints. Moreover, the number of firms, the degree of industry competition and the scale of intermediate products in the downstream sector increase, confirming the market size channel. In sum, our findings document that downstream competition can motivate upstream firms to innovate through vertical industrial chain, providing some useful insights for China to build a fair market competition environment and promote innovation-driven growth regime.

Price Squeezes as an Exploitative Abuse*

The exclusionary theory of price squeezes, commonly debated in courts and among legal scholars, faces significant challenges. This paper introduces an exploitative rationale for price squeezes. A vertically integrated firm can exploit efficiency gains from a downstream competitor, thereby earning more than the monopoly profit, and price squeezing emerges as a necessary condition for such exploitation. Prohibiting price squeezes benefits the competitor and improves production efficiency, but may also lead to unintended, perverse effects. This paper lays an economic foundation for analyzing price squeeze cases and contributes to reconciling the divergence in the case laws between the United States and the European Union.

A Prospective Competitive Effects Analysis of the AT&T/Time Warner Merger

The vertical merger of AT&T and Time Warner combined one of the largest multiple video program distributors (MVPDs) in the United States with one of the largest providers of pay-TV programming. This study evaluates the potential competitive effects of the transaction by considering changes in the equity valuations of the respective upstream and downstream competitors to the merging parties when news of their proposed merger became public. Consistent with the government’s central theory of harm, it appears that financial markets expected the proposed transaction to result in Time Warner increasing its carriage fees to AT&T’s and DirecTV’s MVPD rivals. Market reactions to the announcement of AT&T’s commitment to enter into binding arbitration when negotiating future carriage fees for Tuner content provide further support for this inference. The results are difficult to rationalize in terms of the various efficiencies and synergies that AT&T claimed it would realize from the merger.

Price-Cap Regulation of Firms That Supply Their Rivals

Abstract We study price-cap regulation in a market in which a vertically integrated upstream monopolist sells an essential input to a downstream competitor. In the absence of regulation, entry benefits both firms, but may harm downstream consumers because the upstream monopolist can set a high input price that would push downstream prices above the unregulated monopoly level. However, if a regulator caps the incumbent’s upstream and downstream prices, consumers and firms are better off after entry than under a price-cap monopoly. We extend our model to examine the concern that price caps may induce incumbents to forgo cost-reducing investments and dampen entrants’ incentives to self-provision the input.

Anticompetitive Bundling When Buyers Compete

We study the profitability of bundling by an upstream firm that licenses technologies to downstream competitors and that faces competition for one of its technologies. In an otherwise standard “ Chicago-style” model, the existence of downstream competition can make inefficient bundling profitable. Forcing downstream firms to use an inefficient technology reassures each one that it will face weak competition. This allows the upstream firm to extract more profit through its monopolized technology. A similar logic can make it profitable to degrade interoperability with rival technologies, even without foreclosing competition. Bundling is most profitable when downstream competition is intense and technologies complementary. (JEL D21, D24, D43, D45, G34, L24)

The role of on‐demand delivery platform in competition between manufacturer and retailer

AbstractTraditional retailers can now partner with on‐demand delivery platforms to fulfill consumers' online orders to fight against manufacturers' direct channels. However, it is hard to say whether traditional retailers benefit from cooperating with such platforms due to market encroachment and high commission fees. We build a game‐theoretic model where the manufacturer could decide whether to introduce its direct channel, and the retailer could decide whether to cooperate with the on‐demand delivery platform. We show that when the platform adopts a reasonable pricing and service policy, the retailer can earn more profit when cooperating with the platform. When consumer acceptance of the manufacturer's direct channel is high, the manufacturer should strategically introduce its direct channel even when there are no sales. We also find that the introduction of the platform lowers the retail price at the offline channel, increasing the market's total demand, consumer surplus, and social welfare. The reason lies in the effect of intensifying downstream competition and satisfying the consumer's demand in more market segments.

Sequential licensing with several competing technologies

We assume a multistage oligopoly wherein a given number of innovators compete by selling their substitutive technologies. Each innovator sequentially and independently chooses how many licenses to sell, and subsequently, all licensees compete à la Cournot in the product market. We show that, in equilibrium, the total number of licensees grows exponentially with the number of innovators. In addition, this sequential outcome is also obtained as a subgame perfect Nash equilibrium in pure strategies of a game with endogenous timing. Interestingly, by extending the duopoly model of Badia et al. (Math Soc Sci 108:8–13, 2020) to the case of more than two innovators and exploring pure strategy equilibria instead of mixed strategy equilibria, we derive drastically different policy implications, in terms of patent regulations. Our results suggest that more competition in the upstream market (e.g., by relaxing patent protection against the appearance of similar technologies) tends to increase downstream competition and welfare instead of discouraging or delaying technology adoption. In addition, our analysis is extended to explore the strategic role of public investment in basic R &D.

Vertical Mergers in Ecosystems with Consumer Hold‐Up*

An ecosystem comprises all downstream products that employ a certain upstream input. In many cases, final consumers make irreversible investments to join an ecosystem before downstream prices are set. By committing to buy products that use the specific ecosystem input, they are at risk of being held‐up. Unable to observe future prices, consumers base their decisions on what they observe about the market structure within each ecosystem, including vertical contracts signed by the upstream firms. By entering into vertical agreements with multiple competing downstream firms, thus creating a credible expectation of lower prices, an upstream firm is able to mitigate consumers' hold‐up problem and, as a result, increase ecosystem demand. Our main observation is that, in contrast to conventional wisdom, an upstream monopolist merging with one of its downstream affiliates will find it profitable to continue to serve downstream competitors, even when products sold downstream are homogeneous.

The bright side of outside market entry with manufacturer encroachment

This study discusses the possible benefits of inviting entrants for downstream retailers when facing the encroachment of their upstream manufacturers. We consider a model comprising one retailer, one manufacturer, and one potential entrant. The manufacturer decides whether to encroach or supply the retailer; The retailer decides whether to help a third-party firm overcome its entry barrier. We show that whether firms compete in quantity or price, the manufacturer, in the presence of an entrant, may choose to supply the retailer even if the retailer does not offer any advantages in terms of cost efficiency in retailing or channel differentiation. This is because, in such a scenario, the manufacturer treats the retailer as a strategic collaborator to either restrict the entrant’s market share or alleviate the downstream competition. In other words, triggering the intra-brand competition against the retailer may help the manufacturer perform better in the inter-brand competition against the entrant. On the other hand, the retailer may intentionally prompt entry to trigger inter-brand competition to avoid being foreclosed by the manufacturer and obtain a favorable procurement condition.

The bright side of the planning fallacy in distribution channels

The planning fallacy describes the tendency of people to underestimate the costs and to overestimate the benefits of investments. It is typically associated with cost overruns and decreased performance. In this paper, we demonstrate that in a simple distribution channel with an upstream manufacturer and a downstream retailer that both make demand-enhancing investments, there is a bright side of the planning fallacy: managerial optimism bias that results in underestimated investment costs can in fact lead to a win-win outcome which makes the manufacturer, the retailer, and consumers better off than without bias. Moreover, the total profit of the decentralized distribution channel can be even higher than the centralized channel’s profit. We find that our results are robust to changes in the sequencing of decisions and continue to hold under generalized Nash bargaining over the wholesale price as well as under upstream or downstream competition or consumer demand uncertainty.

Vertical contracting between a vertically integrated firm and a downstream rival

Compared to linear tariffs, two-part tariffs are generally perceived as being more efficient since double marginalization is avoided. We investigate the efficiency of two-part tariffs vs. linear tariffs when a vertically integrated firm sells its input also to an independent downstream firm selling a differentiated substitute product. We find that a linear tariff can generate higher consumer surplus and overall welfare than a two-part tariff when the independent downstream firm is rather powerful in negotiating the contract terms, and downstream competition is in prices (Bertrand competition). In that case, the integrated firm makes more profits under a linear tariff than under a two-part tariff. In contrast, under downstream Cournot competition two-part tariffs are always welfare-superior. Under linear demand, we find that, irrespective of the mode of downstream competition and the distribution of bargaining power, the preferred contract type of the integrated firm is always welfare-superior.

Technology licensing contract design considering royalty transparency and demand information asymmetry with downstream co-opetition

This paper studies how technology suppliers can optimally design licensing contracts when there is incomplete information on the licensee’s demand potential for the product in a high-technology supply chain. A licensing contract typically contains an up-front payment and royalties on product sales. The licensor decides to license one technology to a licensee, which designs products based on the supplier’s technology and outsources the product manufacturing to a competitive downstream manufacturer. We apply principal-agent models to formulate the licensor’s contracting problem while considering the transparency of the licensing royalty and find that under demand information asymmetry, the optimal contract structure changes with the demand potential. More specifically, both the separating and pooling strategies can be the optimal strategies for the licensor under the observable contract case. Conversely, under the unobservable case, only the separating strategy is the optimal licensing strategy. And the licensor can always charge zero royalty to a high-type design firm regardless of the menu strategy or the single contract. Furthermore, we examine the effect of licensing royalty transparency on licensing decisions and firms’ profits and highlight the effect of downstream competition on the licensor’s profit. Our results show that the licensor can be better off in the observable contract case. By contrast, the design firm may be better off in the unobservable contract case. We provide a rationale for the licensing contract design under demand information asymmetry and further shed light on the choice between public and secret licensing terms.

A bane or a boon? Profit‐margin‐guarantee contract in a channel with downstream competition

In recent decades, manufacturers have relied on giant retailers or e‐tailers to distribute their products. Given this evolution, some retailers have started demanding a profit‐margin‐guarantee contract (PMG contract), under which the manufacturer must ensure that the retailer's profit margin does not fall below a certain level (PMG rate). Conventional wisdom suggests that a PMG contract creates a life‐or‐death struggle for the manufacturer and that a retailer with a PMG contract can gain a competitive edge over his competitors. This study investigates the strategic impact of the PMG contract in a competitive environment. We consider a distribution channel consisting of one manufacturer and two competing retailers. In this channel, the manufacturer has signed a PMG contract with one retailer (signed retailer) but not with the other (unsigned retailer). Our analyses show that in response to the PMG contract, the manufacturer can adopt a “ cost‐independent” pricing strategy (i.e., setting the wholesale price independent of the production cost) to strategically trigger or void the PMG contract. For this reason, interestingly, the manufacturer is not always hurt by, nor does the signed retailer always benefit from, the PMG contract. Depending on the production cost and the downstream competition intensity, the PMG contract may yield a win–win, win–lose, lose–win, or lose–lose outcome for the manufacturer and the signed retailer. Moreover, the unsigned retailer may be able to free ride on the PMG contract, making her even better off under this unfavorable competitive situation. Nevertheless, the PMG contract cannot yield a win–win–win outcome for all firms, whereas a lose–lose–lose outcome may arise under certain conditions. Our results have useful managerial and regulatory implications.

Pricing and contract preference in maritime supply chains with downstream competition impact of risk-aversion and contract unobservability

The maritime market has been facing increasingly fierce competition. Most of the existing literature in maritime supply chain assumes that the details of the contracts between ports and carriers are common knowledge among all competing carriers. In reality, it is usually difficult for carriers to be fully aware of each other's contracts with ports. In view of this, we consider two representative contracts, namely wholesale price contact and two-tariff contract, construct a maritime supply chain with one port and two carriers, and analyze how risk-aversion behavior and contract unobservability impact the pricing and contract preference. We use passive beliefs as an equilibrium refinement criterion to solve the model. Our findings indicate that the carrier prefers the wholesale price contract, regardless of whether the contract is observable or not. The port tends to select the two-part tariff contract when the contract is observable. When faced with an unobservable contract, contract preference of the port depends on the competition intensity and degree of risk-aversion. Additionally, under the wholesale price contract, the port can benefit from the decrease of its risk-aversion coefficient and the increase of the carrier's risk-aversion coefficient, while the carrier is exactly the opposite. Meanwhile, the utility of the port can be increased or reduced by the increase in carrier's risk-aversion coefficient under the two-part tariff contract.