The central objective of this paper is to show how vertical restraints, which affect intra-brand competition, can and will be used as an effective mechanism for reducing inter-brand competition and increasing producer profits. We show how exclusive territories alter the perceived demand curve, making each producer believe he faces a less elastic demand curve, thereby inducing an increase of the equilibrium price. The use of exclusive territories may increase producers' profits, even if the producers cannot charge franchise fees, and so cannot recapture, from the retailers, the monopoly rents they earn from their exclusive territory: we show that 'double marginalization' effects can be overcome by the strategic effect on producers' competition. We provide a model in which we can clearly specify the full range of feasible contracts between producers and retailers, and show that it is always a dominant strategy for firms to use exclusive territories (so that exclusive territories are used in equilibrium) and that the best situation from the producers' viewpoint may or may not entail franchise fees. In all cases, exclusive territories hurt consumer surplus and reduce total welfare, which yields a different light on vertical restraints from a competition policy perspective.
*Published:
With Pierre-Andre Chiappori and Ines Macho, published as "Repeated Moral Hazard: The Role of Memory, Commitment, and the Access to Credit Markers", European Economic Review (1994). RAND Journal of Economics, Vol. 26, no. 3 (1995): 431-451.
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