Downstream Competition Research Articles

Cost pass-through and inverse demand curvature in vertical relationships with upstream and downstream competition

This paper provides two characterizations of the retailer’s markup relative to the manufacturer’s markup in vertical relationships with homogeneous manufacturers and homogeneous retailers. We first show that retailer’s relative markup is equal to the ratio of the retail pass-through to the wholesale pass-through, multiplied by the number of manufacturers relative to the number of retailers. We then provide its expression in terms of the inverse demand curvature.

Airport–airline cooperation under commercial revenue sharing agreements: A network approach

This study analyzes airport–airline cooperation where an airport offers to share a proportion of its commercial revenue with airlines in exchange for a fixed payment. We observe the revenue share allocation that maximizes airport profit, subject to airline acceptance, and examine the effects of revenue sharing on downstream competition and social welfare. Methodologically, we employ multi-airport multi-airline non-cooperative games with a network model and find that an airport prefers to share revenue with its dominant airline in order to gain the optimal benefit.

Robust Exclusion and Market Division Through Loyalty Discounts

We show that loyalty discounts create an externality among buyers because each buyer who signs a loyalty discount contract softens competition and raises prices for all buyers. This externality can enable an incumbent to use loyalty discounts to effectively divide the market with its rival and raise prices. If loyalty discounts also include a buyer commitment to buy from the incumbent, then loyalty discounts can also deter entry under conditions in which ordinary exclusive dealing cannot. With or without buyer commitment, loyalty discounts will increase profits while reducing consumer welfare and total welfare as long as enough buyers exist and the entrant does not have too large a cost advantage. These propositions are true even if the entrant is more efficient and the loyalty discounts are above cost and cover less than half the market. We also prove that these propositions hold without assuming economies of scale, downstream competition, buyer switching costs, financial constraints, limits on rival expandability, or any intra-product bundle of contestable and incontestable demand.

Competition, Licensing, and Innovation Strategy

We consider an upstream innovator and two downstream competitors; and examine the impact of product market competition on the innovator's R&D strategy, when she can license her innovations to either one downstream competitor (targeted licensing) or both (market-wide licensing). We show that downstream competition unambiguously increases the appeal of targeted licensing over market-wide licensing. Moreover, competition increases the innovator's incentives to innovate under targeted licensing, but decreases these incentives under market-wide licensing. Thus, a threshold level of competition may exist such that above (below) that threshold, targeted (market-wide) licensing is optimal and innovation is increasing (decreasing) in competition. Using U.S. data across all industries over the period 1976--2006, we then empirically investigate the impact of downstream competition on upstream innovation. We find that there is an U-shaped relationship between downstream competition and upstream innovation. Furthermore, using import tariff rates as a quasi-natural experiment, our identification tests suggest that downstream competition has a non-linear causal effect on upstream innovation.

Managing Competing Channels through Nonlinear Contracts

An upstream supplier constrained by downstream competition and the threat of demand-side substitution faces a trade-off between maximizing overall joint-profit and extracting surplus. By inducing more intra-brand competition through lower wholesale prices, the supplier makes it less attractive for downstream firms to switch to alternative sources of supply. This insight yields various implications that are strikingly different from those of extant models of vertical contracting: (1) Though the supplier can control competing channels through non-linear supply contracts, marginal wholesale prices and final goods' prices both decrease when either down- stream competition intensifies or the supplier becomes more constrained by the threat of demand-side substitution. (2) It may be optimal for the supplier to balance his sales across competing channels through disadvantaging more efficient downstream firms, thereby smoothing out differences in market shares.

Collusive Effects of a Monopolist's Use of an Intermediary to Deliver to Retailers

A manufacturer contracting secretly with several downstream competitors faces an opportunism problem, preventing it from exerting its market power. In an infinitely repeated game, the opportunism problem can be relaxed. We show that the upstream firm's market power can be restored even further if the upstream firm chooses a mixed distribution system in which it makes use of an intermediary to distribute the good to a subset of the retailers and delivers directly only to the remaining downstream firms.

Collaborate or Consolidate: Assessing the Competitive Effects of Production Joint Ventures

We analyze a symmetric joint venture in which firms facing external competition collaborate in input production. Under standard regularity conditions, the collaboration leads to higher profits than a horizontal merger, whereas the effect on prices and quantities depends on the form of downstream competition. When firms compete in prices, downstream prices for all firms are higher following a symmetric joint venture than following a merger. The reverse result may obtain under quantity competition. In light of our results regarding profits, we provide reasons why firms might still wish to merge: imperfect information, cost synergies, and organizational asymmetries.

The Strategic Role of Third-Party Marketplaces in Retailing

Retailers are increasingly adopting a dual-format model. In addition to acting as traditional merchants (buying and then reselling goods), these retailers also provide a platform for third-party sellers to access and compete for the same customers. In this paper we investigate the strategic rationale for a retailer to introduce a third-party (3P) marketplace, by addressing the following questions: how does the existence of the 3P marketplace alter the outcome of the bargaining game between a manufacturer and the retailer and how does it affect their profits? Our analysis provides insights into the growing prevalence of 3P marketplaces. We show that by committing to having an active 3P marketplace the retailer creates an that improves its bargaining position in negotiations with the manufacturer. This can explain the increasing prevalence of such marketplaces. On the other hand, the manufacturer would prefer to eliminate this retailer's outside option and should seek to limit or prevent sales through 3P marketplaces. This is consistent with actions that several manufacturers have taken to limit such sales. Interestingly, if the manufacturer fails to eliminate sales of competing products through the 3P marketplace, then the best strategy for the manufacturer is to allow the retailer to dictate the terms of their contract. This is due to the fact that an all-powerful retailer will rely less on its outside option in generating profit, and therefore it will increase the fees charged to 3P sellers and soften the competition between 3P sellers and the manufacturer. The decrease in competition will lead to an increase in the value of outside option of the manufacturer and improve its profit. Additionally, we find that the presence of a 3P marketplace benefits consumers (due to the introduction of downstream competition), but this benefit diminishes as the retailer is becoming more powerful.

Countervailing Power and Input Pricing: When is a Waterbed Effect Likely?

A downstream firm with countervailing power can extract a reduced price from an input supplier. A waterbed effect occurs if this price reduction leads the input supplier to raise the price that it charges another downstream firm. Policy makers have been concerned that this waterbed effect could undermine downstream competition and it was considered in detail in the 2008 UK grocery inquiry. This paper presents a simple but parsimonious model to investigate if and when a waterbed effect may arise. It shows that the effect may arise through optimal pricing behaviour, but that this critically depends on the nature of upstream technology, downstream competition and consumer demand. In particular, downstream competition tends to work against a waterbed effect, but convex upstream costs support the effect. The analysis is complementary to recent academic work on the waterbed effect that focuses on bargaining constraints.

Downstream horizontal integration and multiunit dealership

In this paper, a game theoretical model featuring a manufacturer and two dealers has been proposed to investigate the belief that horizontal integration in an established network and granting of regional multiunit dealership in a growing network improve the manufacturer's profit. Some of the main results are as follows: (1) the manufacturer and dealers are mutually better off when integration and multiunit dealership lead to an increase in consumer demand through higher prices and better investments in services and national advertising, (2) downstream integration and multiunit dealership harm the manufacturer's profit when the integrated dealer aims to free-ride the manufacturer's brand or local service has no impact on consumer demand, (3) under certain conditions, both the manufacturer and dealers prefer downstream competition to integration regardless of whether it increases or reduces retail prices. Finally, mechanisms to implement horizontally integrated strategies in an established dealer network made of multiple single-unit dealers such as the use of resale price maintenance (RPM), exclusive territory agreement, and dealer cuts are discussed.

Upstream Mergers, Downstream Competition, and R&D Investments

In this paper, we provide an explanation for why upstream firms merge, highlighting the role of R&D investments and their nature, as well as the role of downstream competition. We show that an upstream merger generates two distinct efficiency gains when downstream competition is not too strong and R&D investments are sufficiently generic: The merger increases R&D investments and decreases wholesale prices. We also show that upstream firms merge unless R&D investments are too specific and downstream competition is neither too weak nor too strong. When the merger materializes, the merger‐generated efficiencies pass on to consumers, and thus, consumers can be better off.

Optimal access regulation with downstream competition

We analyze the setting of access prices for a bottleneck facility where the facility owner also competes in the deregulated downstream market. We consider a continuum of market structures from Cournot to Bertrand. These market structures are fully characterized by a single parameter representing the intensity of competition. We first show how the efficient component pricing rule should be modified as the downstream competitive intensity changes. We then analyse the optimal access price where a regulator trades off production efficiency and pro-competitive effects to maximize total surplus.

On the competition enhancing effects of exclusive dealing contracts

Antitrust scholars have argued that exclusive contracts have anticompetitive, or at best neutral effects, if no efficiencies are generated. In contrast, this paper shows that exclusive contracts can have procompetitive effects, provided buyers are imperfect downstream competitors and contract breach is feasible. In that case, an efficient entrant is not necessarily foreclosed through exclusive contracts but induces buyers to breach. Because breaching buyers have to pay expectation damages to the incumbent, the downstream profits they obtain when breaching must be large enough. Therefore, the entrant needs to set a lower wholesale price than absent exclusive contracts, leading to lower final consumer prices and higher welfare.

Upstream Competition with Non-Linear Pricing and Contracts that Reference Rivals

The competitive effects of a number of vertical restraints, such as no-surcharge rules (common in the credit card industry) and market-share requirements (common in many other industries), have been at the center of a recent policy debate. This paper develops a model of bilateral vertical contracting in successive duopolies to study the effects of these restraints on the intensity of upstream competition. When suppliers offer menus of non-linear tariffs and are sufficiently differentiated, both downstream firms purchase inputs from both suppliers, who charge input prices above marginal cost to soften downstream competition. In such equilibria, vertical restraints such as no-surcharge/no-steering rules or market-share and/or minimum volume requirements soften upstream competition and lead to higher prices. Selective bans on only one type of restraint may, however, have unintended consequences. For example, a ban on minimum volume requirements may reduce welfare when no-surcharge rules or share requirements are allowed or when it results in exclusive equilibria.

Refusal to Deal, Intellectual Property Rights, and Antitrust

A vertically integrated firm, having acquired the intellectual property (IP) through innovation to become an input monopolist, can extract surplus by supplying efficient downstream competitors. That the monopolist would refuse to do so is puzzling and has led to numerous debates in antitrust. In this paper, I clarify the economic logic of refusal to deal, and identify conditions under which prohibiting such conduct would raise or lower consumer and social welfare. I further show how IP protection (as determined by IP laws) and restrictions on IP holders' conduct (as determined by antitrust laws) may interact to affect innovation incentive and post-innovation market performance.

Multilateral Bargaining and Downstream Competition

We examine multilateral bargaining in vertical supply relationships that involve an upstream manufacturer who sells through two competing retailers. In these relationships the negotiations are interdependent, and bargaining externality may arise across the retailers. In addition, the timing by which the manufacturer negotiates with the retailers becomes important. In simultaneous bargaining the retailers negotiate without knowing if an agreement has been reached in the other retail channel, whereas in sequential bargaining the retailer in the second negotiation is able to observe whether an agreement was reached in the first negotiation. We show that simultaneous bargaining is optimal for the manufacturer when the retail prices (and profitability) are similar, and sequential bargaining is preferred when the dispersion in the retail prices is sufficiently large. As a result of ex post renegotiations, the manufacturer may strategically stock out the less profitable retailer who charged a relatively low retail price and exclusively supply only the retailer who charged a relatively high retail price and maintained high channel profitability. Moreover, ex post multilateral bargaining can buffer downstream competition and thus lead to positive retail profits even in markets that are close to perfect competition.

Spectrum Floors in the UK 4G Auction: An Innovation in Regulatory Design

This paper evaluates the regulatory approach to competition issues in the UK 4G spectrum auction which involved the innovative use of spectrum floors, the flexible reservation of portfolios of spectrum for either a new entrant or the smallest incumbent national mobile competitor (H3G). Spectrum floors have two dimensions of flexibility: different portfolios of spectrum can be reserved for different players, eg depending on their pre-auction spectrum holdings; and the choice of spectrum to be reserved from a range of portfolios, each of which is sufficient to promote competition, is decided through the auction as the floor that minimises the opportunity cost of reservation. The use of spectrum floors appropriately emphasised output efficiency through promoting downstream competition. But its implementation in the auction sought also to maximise auction efficiency (subject to the constraint of the floor) through sophisticated modifications to the already complex design of the combinatorial clock auction. This approach represented a balance between the risks of market and regulatory failure. On the one hand, H3G or a new entrant might fail in the auction to acquire the spectrum required for promotion of downstream competition because of asymmetries in intrinsic value compared to social value or strategic investment by the larger incumbents (EE, Telefonica and Vodafone) to deny spectrum to competitors. On the other hand, using the traditional approach of spectrum set-aside there might be a high opportunity cost of reservation through choosing the wrong spectrum to be reserved. In the UK 4G auction held in January to February 2013 the full potential of spectrum floors was not, in the event, tested because there was no competition between bidders eligible to obtain reserved spectrum - H3G was the only such bidder willing to pay the reserve price of the spectrum floors. However, there was still competition over the choice of spectrum floor for H3G, which resulted in an outcome that some considered surprising. H3G won the spectrum floor of 2x5MHz in the higher-value 800MHz band, ie scarce sub-1GHz spectrum, rather than 2x20MHz in the higher-frequency 2.6GHz band. By analysing the bid data, a comparison of these two floors shows that the marginal value in H3G’s package bids of £165m exceeded the overall opportunity cost to other bidders of £107m. This outcome was not a fluke or an aberration as it clearly reflected the consistent pattern of bids made in the auction. In particular it reflected H3G’s strategy of bidding marginal values for the floor packages equal to the differences in their reserve prices, which guaranteed that it would not pay more than the reserve price for its winning spectrum floor; and EE’s consistently aggressive bidding at the margin for 2x20MHz of 2.6GHz compared to 2x5MHz of 800MHz. Based on the bids made in the auction it was clearly more efficient for H3G to win the spectrum floor of 2x5MHz of 800MHz, even if this might not have been the prediction before the auction. With the important caveat that some of the bidding may have been strategic and deviated from bidders’ true intrinsic values, this suggests that one of the key elements of flexibility in the new regulatory tool of spectrum floors proved to be important the first time it was used in the UK 4G auction. This flexibility avoided the regulatory failure that could have occurred with simple spectrum set-side of the regulator reserving less efficient pre-specified spectrum in the false belief that would minimise the opportunity cost of spectrum reservation.

A competition‐based explanation of collaborative invention within the firm

Existing literature shows that collaborative invention within the firm enhances innovativeness by facilitating knowledge recombination. Despite such benefit, firms vary in their use of collaborative invention when drawing on their individual inventors' knowledge. In addressing this puzzle, we argue that competition from rival products building on similar knowledge compels firms to favor search depth over exploratory search and respond expeditiously, thus reducing a firm's inclination toward collaborative invention. In contrast with prior research's focus on how upstream resources influence a firm's position in downstream markets, this study shows that downstream competition drives heterogeneity across firms in their utilization of upstream resources. Copyright © 2013 John Wiley & Sons, Ltd.

Margin Squeeze in a Regulatory Environment: An Application to Differentiated Product Markets

This paper analyses the effects of banning pricing policies that lead to margin squeezes when the upstream good is imperfectly regulated. The analysis relies on a modelling with a vertically integrated upstream monopolist that faces competition by an unintegrated downstream competitor. It shows that for differentiated goods in the downstream market, a margin squeeze can be observed as the competitive outcome rather than exclusionary conduct. If upstream market regulation is non-constraining, a margin squeeze ban induces the vertically integrated firm to increase its own downstream price (this is, a price umbrella), but also to review its upstream pricing behavior and reduce the upstream price charged to the retail competitor. This decreasing rivals' costs effect (DRC-effect) allows the integrated firm to maximise its profits given the constraint on the downstream price, and allows the downstream competitor to set a lower retail price. However, when constraining upstream regulation and a ban are implemented jointly, the DRC-effect vanishes and downstream prices may to rise, leading to a decrease of consumer surplus. This analysis tends to back up the American way of handling margin squeezes in a regulated environment.

Managing Downstream Competition via Capacity Allocation

Consider a supply chain with one supplier and multiple retailers. The supplier produces a single product and sells it to the retailers, who in turn sell the product to consumers. The supplier has limited production capacity, and the retailers are engaged in a Cournot competition at the consumer/market level. When the sum of the retailer orders exceeds the capacity, the supplier allocates her capacity according to a pre‐announced allocation mechanism. Two mechanisms are considered: proportional allocation and lexicographic allocation. An extensive study of the two allocation mechanisms shows that the lexicographic mechanism has the ability to dampen the competition at the retail level, increasing the profits for both the supplier and the supply chain.