Vertical Separation with Private Contracts

Abstract

We consider a manufacturer's incentive to sell through an independent retailer, rather than directly to final consumers, when contracts with retailers cannot be observed by competitors. If retailers conjecture that identical competing manufacturers always offer identical contracts (symmetry beliefs), vertical separation by all manufacturers is an equilibrium, and it results in higher consumers' prices and manufacturers' profits. Even with private contracts, vertically separated manufacturers reduce competition by inducing less aggressive behaviour by retailers in the final market. We characterize a condition for manufacturers' profits to be higher with private than with public contracts. Our results hold both with price and with quantity competition, and do not hinge on retailers' beliefs being perfectly symmetric.Delegation, vertical separation, private contracts, symmetry beliefs