Downstream Competition Between an Upstream Supplier and an Independent Downstream Firm

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Submitted By mikiying
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Downstream competition between an upstream supplier and an independent downstream firm by Yaron Yehezkel*

Preliminary and incomplete March, 2003

Abstract: I consider an upstream supplier that supplies an input to an independent downstream firm and in addition sells the final product to consumers. I find that the upstream supplier cannot implement the monopoly outcome without imposing maximum resale price maintenance (RPM). RPM increases social welfare if

consumers’ valuation for the final product of the downstream firm is high, and decreases social welfare otherwise. When the downstream firm is privately informed about the demand it faces, entry into the downstream market serves as a countervailing incentive that allows the upstream supplier to reduce the information rents. Consequently, asymmetric information induces the upstream supplier to enter the downstream market even if entry is not profitable under full information.

Keywords: dual distribution, two-part tariff, resale price maintenance, information rents, countervailing incentive JEL Classification Numbers: L41, L42, D82

* I thank Koresh Galil, Asaf Ravkai, Yossi Spiegel, Manuel Trajtenberg, Marisa Trajterman and seminar percipients at Tel Aviv University for helpful comments. * Tel Aviv University, Ramat Aviv, Tel Aviv, 69978, Israel. Email: .

2 1. Introduction
Upstream suppliers often adopt a dual distribution system whereby they not only sell their products to retailers but also enter the downstream market and sell their products directly to final consumers. This situation is common in the U.S. automobile industry (Banks, 1993), franchising (Brickley and Dark, 1987; Lafontaine, 1992), and fragrance and DVD players (Carlton and Chevalier, 2001). In the later case, manufacturers sell directly to consumers through their Internet websites in addition to selling their products to…...

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