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Vertical coordination through renegotiation

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  • Bedre-Defolie, Ö.

Abstract

This paper analyzes the strategic use of bilateral supply contracts in sequential negotiations between one manufacturer and two differentiated retailers. The first main result is that, despite the feasibility of general supply contracts which are functions of own quantity (but cannot be contingent on the rival's quantity), the first contracting parties have incentives to manipulate their contract to shift rent from the second contracting retailer and these incentives distort the industry profit away from the fully-integrated monopoly outcome. The second main result is that if the contract terms between the manufacturer and the first retailer can be renegotiated from scratch in the event that the second retailer has no agreement, then the monopoly outcome can be achieved, often with full rent extraction from the second retailer. Moreover, there are conditions under which renegotiation from scratch yields higher joint profit for the firstly contracting parties than no renegotiation. These results do not depend on the type of retail competition, the level of differentiation between the retailers, the order of sequential negotiations, the level of asymmetry between the retailers in terms of their bargaining power vis-à-vis the manufacturer, or their profitability from being the monopoly retailer.

Suggested Citation

  • Bedre-Defolie, Ö., 2012. "Vertical coordination through renegotiation," International Journal of Industrial Organization, Elsevier, vol. 30(6), pages 553-563.
  • Handle: RePEc:eee:indorg:v:30:y:2012:i:6:p:553-563
    DOI: 10.1016/j.ijindorg.2012.05.002
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    References listed on IDEAS

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    1. Daniel P. O'Brien & Greg Shaffer, 1992. "Vertical Control with Bilateral Contracts," RAND Journal of Economics, The RAND Corporation, vol. 23(3), pages 299-308, Autumn.
    2. Bedre-Defolie, Ö., 2012. "Vertical coordination through renegotiation," International Journal of Industrial Organization, Elsevier, vol. 30(6), pages 553-563.
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    14. Lars A. Stole & Jeffrey Zwiebel, 1996. "Intra-firm Bargaining under Non-binding Contracts," Review of Economic Studies, Oxford University Press, vol. 63(3), pages 375-410.
    15. McAfee, R Preston & Schwartz, Marius, 1994. "Opportunism in Multilateral Vertical Contracting: Nondiscrimination, Exclusivity, and Uniformity," American Economic Review, American Economic Association, vol. 84(1), pages 210-230, March.
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    1. Bedre-Defolie, Ö., 2012. "Vertical coordination through renegotiation," International Journal of Industrial Organization, Elsevier, vol. 30(6), pages 553-563.

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