In a forthcoming paper in The Journal of Industrial Economics, Founding Partner Mark Israel and co-authors Michele Bisceglia, Salvatore Piccolo, and Paolo Ramezzana examine the effects of vertical integration together with resale price maintenance.
The authors study a situation with two upstream manufacturers competing to be carried by a single downstream retailer, thus capturing the situation in which a retailer has market power in a tractable way. They show that in the presence of double moral hazard—which describes the common situation in which efforts taken by both the manufacturers and the retailer boost demand for the final product, but these efforts cannot be fully observed and spelled out in contracts—resale price maintenance (RPM) is optimal for each manufacturer in the absence of vertical integration. And such RPM increases consumer welfare.
Importantly, they also show that the common antitrust intuition that RPM solves the double marginalization problem and thus eliminates the benefits of vertical integration—and perhaps makes vertical integration harmful—does not hold in general. Instead, when effort is reasonably important (or product differentiation is high or low), incentivizing retailer effort absent vertical integration requires large retailer margins, which reintroduces double marginalization, even in the presence of RPM, meaning vertical integration increases consumer welfare and can even increase the profits of the unintegrated manufacturer.
This has important antitrust implications, as it means that competition agencies should not assume that RPM “solves” double marginalization and renders vertical integration unnecessary in cases where effort is important; instead, incentivizing effort via retailer margins can drive a wedge between price and cost in the presence of double moral hazard that vertical integration can efficiently solve.
The views and opinions expressed in this response are those of the authors and do not necessarily reflect the views of Econic Partners or its clients.
