Contracting and Vertical Control by a Dominant Platform

Abstract

Online platforms increasingly act as gatekeepers that enable producers to access downstream markets, while also competing with producers in these downstream markets. A prominent example is Amazon, which sells e-commerce and distribution services to producers in an upstream market, while also selling AmazonBasics and other private-label products downstream. Should platforms be allowed to control whom they compete with in downstream markets through their upstream market interactions? In this paper, we study the antitrust implications of a platform acting both as a producer in a downstream market and an upstream supplier to rival producers. We find that banning a monopolist platform from producing in downstream markets can only harm consumers because platforms that produce positive output in equilibrium always reduce downstream prices. Consequently, the claimed "conflict of interest," or tradeoff between the platform's upstream and downstream profits, always benefits the consumer, at the expense of producers. Intuitively, any output produced by the competitive fringe of producers is associated with a vertical externality that resembles double marginalization, while any output produced by the platform is only associated with a single marginalization effect. If the platform's own production costs are reduced, the corresponding substitution towards output produced by the platform results in higher overall production in the downstream market, which benefits consumers. However, when the platform is not a monopolist, meaning that producers can access downstream markets through alternative distribution channels, platforms may have an incentive to undermine this upstream market competition. For example, the platform may profitably engage in "killer" horizontal acquisitions (acquire and then shuttering smaller upstream competitors) or exclusive dealing (offer contracts that preclude producers from accessing alternative distribution channels). These practices harm consumers by reducing overall output in the downstream market and would therefore warrant the scrutiny of antitrust authorities. Our analysis introduces a general mechanism design framework for studying vertical market structures involving a dominant platform. In particular, we consider a model in which a platform sells a productive input to producers in an upstream market before competing with these producers in a downstream market. We characterize the optimal menu of contracts offered by the platform in the upstream market, assuming the platform seeks to maximize its total upstream and downstream profits. In our formulation, producers have private information about their costs, which gives rise to incentive and participation constraints. We first consider the case in which the platform monopolizes the upstream market and then add the possibility that producers have access to alternative distribution channels. In each case the optimal menu of upstream contracts involves a nonlinear pricing schedule that represents price discrimination in the form of quantity discounts. An implication of our consumer surplus analysis for antitrust policy is that banning platforms from producing in downstream markets can only harm consumers. A similar result holds if the platform is banned from selling downstream market access in the upstream market. This suggests that there is more to the "conflict of interest" identified by antitrust authorities than meets the eye. Naturally, consumers would be better off if the platform's upstream business interests were separated from its downstream business interests. However, this may be difficult to achieve in practice and our analysis shows that simple bans will only serve to make consumers worse off. This resonates with recent antitrust policies. For example, in 2019 India introduced new laws---intended to protect small local businesses---that prevented online retailers from selling products through vendors in which they hold an equity stake. Amazon lobbied strongly against this new law, which prevented it from selling AmazonBasics products on its own platform. Our analysis suggests that while such laws should indeed protect the interests of producers, they may harm consumers.