Wholesale price discrimination: Innovation incentives and upstream competition

AuthorIoana Chioveanu,Uğur Akgün
Published date01 June 2019
DOIhttp://doi.org/10.1111/jems.12284
Date01 June 2019
Received: 24 April 2017
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Revised: 20 July 2018
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Accepted: 23 July 2018
DOI: 10.1111/jems.12284
ORIGINAL ARTICLE
Wholesale price discrimination: Innovation incentives and
upstream competition
Uğur Akgün
1
|
Ioana Chioveanu
2
1
Charles Rivers Associates, London, UK
2
Department of Economics and Finance,
Brunel University London, London, UK
Correspondence
Ioana Chioveanu, Department of
Economics and Finance, Brunel
University London, UB8 3PH,
London, UK.
Email: ioana.chioveanu@brunel.ac.uk
Abstract
In intermediate good markets where there are alternative supply sources,
wholesale price discrimination may enhance innovation incentives down-
stream. We consider a vertical chain where a dominant firm and a competitive
fringe supply imperfect substitutes to duopoly retailers which carry both
varieties. We show that a ban on price discrimination by the dominant supplier
makes uniform pricing credible and reduces retailersincentives to decrease the
cost of acquiring the competitively supplied variety, leading to higher upstream
profits and lower downstream welfare. Our analysis complements existing
results by identifying a novel channel through which wholesale price
discrimination can improve dynamic market efficiency.
1
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INTRODUCTION
The literature on price discrimination in intermediate good markets has focused mainly on situations where an
upstream supplier is unconstrained or where downstream firms single source. However, downstream firms often have
access to different suppliers, rather than being locked into a single upstream supplier. They also frequently multisource
and do not allocate all of their volume to a single supplier on the basis of price alone even when upstream firms produce
a relatively homogenous input for their product.
1
Moreover, if there is differentiation between the products of the
upstream firms, then downstream firms may be purchasing from different suppliers to produce different varieties of
their own products. Indeed, when the downstream activity is retailing, often multiple upstream differentiated suppliers
products are sold by each downstream competitor. For example, grocery stores commonly sell both branded products
supplied by dominant manufacturers and differentiated varieties, including private labels.
This paper revisits the impact of price discrimination by a dominant supplier on downstream innovation incentives
and welfare in a model where downstream firms resell both the suppliers product and a differentiated substitute
available from a competitive fringe. We identify downstream firmsinvestment in reducing the cost of access to the
differentiated alternative as a novel channel through which wholesale price discrimination may improve the dynamic
efficiency of the market. A lower cost of accessing the fringe product may result from the retailer investing in own
distribution assets specific to that product.
2
If a monopoly supplier price discriminates against singleproduct downstream firms, the retailers which are more
efficient in retailing pay a higher price because their demand for the suppliers product is less elastic (DeGraba, 1990;
Katz, 1987). This distortioneffect (handicapping of more efficient firms) is also present in our setting with upstream
competition and multiproduct retailers. However, we focus on an additional effect by distinguishing between
downstream firmsrelative efficiency in retailing and their relative efficiency in acquiring the differentiated substitute.
© 2018 The Authors. Journal of Economics & Management Strategy Published by Wiley Periodicals, Inc.
J Econ Manage Strat. 2019;28:510519. wileyonlinelibrary.com/journal/jems
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This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and reproduction in any medium, provided
the original work is properly cited.

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