Endogenous vertical structure with network externalities

This study examines the endogenous vertical structure in which each manufacturer sells its product to its exclusive retailer who sells network goods to consumers (i.e. a duopoly in the upstream market) under Bertrand competition and Cournot competition with network externalities. We show that with strong (weak) network externalities under Bertrand competition, (a) it is a dominant strategy for each manufacturer to integrate (separate) its retailer; (b) with strong network externalities, the manufacturers’ profits, consumers’ surplus and social welfare are higher under vertical integration than under vertical separation. Under Cournot competition, (a) vertical separation is a unique subgame perfect Nash equilibrium; (b) with strong network externalities, the manufacturers’ profits, consumers’ surplus and social welfare are higher under vertical separation than under vertical integration.